Give a person 5 euro and he will be happy. Take it back and that person will be very sad. In the end the person now has the same as at the start. Does this makes sense? Probably not. It illustrates that people are happy with a gain but are more unhappy with a loss.
This is important to understand when you invest. You need to be sure that a potential loss will not make you unhappy. And you need to prepared for that.
When you invest, you put money at work for you in the markets. One of the main characteristics of the markets is that they move up and down all the time. Sometimes they will go really high. You will be happy. Then the markets will go lower. You will not be happy. The market can even correct (-10pct) or crash. That will make you feel miserable. As long as you do not sell when you have a profit or a loss, it is a paper loss in a brokerage account.
Image you log on and see a nice profit of 150 euros in your brokerage account. You start to smile and feel good. You might feel smart and decide to invest even more, based upon your paper profit.
A week later, you check in and see that you now are down 50 euros. What happened? did you loose your smart. You start to feel bad and might figure that investing is nothing for you. In a moment of sadness, you go and sell all. The paper loss is now a real loss. Is that smart?
what went wrong?
A lot of things could have gone wrong. The good news is that you can learn from the mistakes of others and try to make the wrong decisions.
Markets move, they go up and down.
The fancy term is volatility. Over the long long historical run – think periods of 20/30 year – there has been an almost 100 pct probability that you made a profit. But profit does not mean you had no paper loss. It is guaranteed that the next correction or crash will come. With a paper loss. And the loss will be real if you sell. The down market will be followed by rising markets. So, now you know that, take it into account when you invest. Don’t act as if you did not know that the stock market could go down.
Make a plan before investing and stick to it.
There are many plans available: index investing, dividend investing, technical analysis,… Each plan has its own mechanics that you need to understand and respect if you want to be successful in the long term. Just be aware that there will be bumps in the road with each plan. Just think ahead of what you will do. Will you take the paper loss? Or will you invest more and us the market dip as an opportunity?
Don’t depend on your investments for emergencies
A great way to avoid paper loss is not having to sell in a bear market due to an emergency. You will be forced to sell at a price you might not like. The solutions to this are easy
- have an emergency fund: this should cover 6-12 months of expenses, or even more
- have some 100 pct save investments
- plan some investments ahead of time and save for them
Adjust your investing to your risk profile
This is actually easy said, but more hard to do. It requires you to know your risk profile. This is one of the hardest things to do. A lot of people think they tolerate a lot of risk (paper loss is a good alternative to describe risk). When people see the size of that paper loss, they might be surprised by their own reaction.
Next to that, you need to adjust your investments to your risk profile. How do you do that? by adjusting your asset allocation. In short: an asset allocation describes how much bonds and stocks you have. Due to the nature of these products, it helps you tune the risk you take.
Sounds complicated? Yes! Luckily, there are some rules of thumbs you could use.
- have 100-your age in stock. The rest in bonds. I am almost 40, so, I would need to have 60 pct stocks, the rest in bonds
- look at the time horizon of your investment goal. If it has 20 years to go, you can go almost to 100 pct stocks, if it is less, reduce the stocks. An example could be to reach 20pct stock when you have 5 years to go. and reach Almost 0 pct in the last 2 years or so.
- Use some historical data to see what combination gives what expected loss
Don’t look all the time
If you have a plan in place, you believe in it and your asset allocation is under control, what then would be a reason to look each day, each break or each hour? There is no reason. So, don’t. Again, it is easier said then done.
The way i deal with it: my core investments are looked at each month and reported on the blog. This way, I have some time to review and reflect: is all still as I intend it to be?
Then there are my play investments. That is another story… I still work on sticking to the plan here.