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When is a loss not a loss?

Recently we have heard a lot of commentary about how much people have lost on their investments due to the fall in investment markets because of the COVID-19 pandemic.

Have these people actually lost any money? Possibly, but then possibly not. Let me explain

I have always been more of a left than right brain thinker, so using a mathematical example of

2 + 2 = 4

Change or remove either of the two’s and sum does not work. For example 2+3 ≠ 4 nor does 2 ≠ 4

The comparative investment equation would be:

Decline in portfolio value + Decision to sell = Loss

As with the mathematical example by removing any part of the equation whether “Decline in portfolio value” or “Decision to sell” would not equate to a “Loss” as both must be present.

Therefore, why would someone sell and create a loss when their portfolio has decreased. There are many reasons that are beyond the scope of this article, but I suspect the common ones would be:

  1. Fear values will fall further
  2. Fear values may never recover
  3. Need for the money now

Let us look at each:

  • Fear values may fall further

This is entirely possible; you might even say probable until the way out of the Pandemic is clearer. Assuming you still intend to remain invested at some point then selling is only half the answer, the other half is knowing when to buy back into the investments. This is more commonly known as market timing – a feat that our evidence indicates is extremely difficult to do.

  • Fear values may never recover

Again this is possible (this time might be different) but is it probable? Our evidence is that for a globally diverse portfolio every previous decline has been temporary.

My personal view is that if values were never to recover then the cause of this would have such an effect on our personal/professional lives that a fall in investment values might be the least our worries.

  • Need for the money now

We cannot predict the future, nor our need for money in the future. What we can do is make prudent assumptions and set aside an amount in cash (we recommend typically an emergency fund for lifestyle costs and an amount of known capital costs over the next five years for example a dream holiday or a new car)

Hopefully this will avoid the need to sell investments at a time when they have reduced in value.

Yes, this still might need to happen but it is about trade-offs as the alternative is to be 100% in cash 100% of the time – this may or may not be the right things given the objectives for the money.

So, in summary it might sound pedantic to say “temporary decline” rather than “loss” but for me not only is it a better way of framing the situation, but the positive nature of the former may have a positive subliminal effect on us all.

This article represents the opinion of Clover Wealth Management and is intended as information only. The content of this article should not be construed as advice or recommendation.