There is no way to avoid losses in the stock market, and if you invest in stocks, you are likely to lose money at some point. Sometimes, the loss is immediate and obvious, such as when the price of the stock you bought falls below the purchase price. In other cases, the losses may not be apparent as they are more gradual and occur over a longer period.
Capital Losses
This type of loss is the simplest and perhaps the most painful: you buy a stock and then watch its price drop and continue to decline. You decide to end the pain and sell it at some point. This type of loss is referred to as a capital loss because the price at which you sell the capital asset was lower than the cost of purchasing it.
Opportunity Losses
This type of loss is less painful and harder to quantify, but it is very real. You might have bought $10,000 of a hot growth stock, and the stock is very close to the price you paid after a year, after some volatility. You might be tempted to tell yourself, “Well, at least I didn’t lose anything.” But that isn’t true. You tied up $10,000 of your money for a year and didn’t earn any return. You would have at least earned a little interest during that same year if you had put your money elsewhere, such as in a Certificate of Deposit (CD). This is known as opportunity loss or the cost of alternative options.
Losses in Missed Profits
This type of loss occurs when you watch a stock rise significantly and then retreat, which can easily happen with more volatile stocks. Many fail to predict the peak or the bottom of the market or an individual stock. You may feel that the money you could have made is lost money – money you would have gotten if you had sold at the peak. Many investors hold steady and hope the stock rebounds and recovers to its peak again, but that may never happen. Some investors may be tempted to hold on again if it does, hoping for even bigger profits, only to see the stock drop again. The best remedy for this type of loss is to have an exit strategy in place – and to be happy with a reasonable profit.
Paper Losses
You might tell yourself, “If I don’t sell, then I haven’t lost anything,” or “Your loss is only a paper loss.” Although it is just a loss on paper and not in your pocket (yet), the fact is that you must decide what to do about it if your investment in a stock has taken a hit. It might be the right time to increase your holdings if you believe the company’s long-term prospects are still strong and you are a value investor. On the other hand, your paper loss will become an opportunity loss if the stock continues to perform below expectations.
How to Deal with Your Losses
No one wants to incur any type of loss, but the best option often is to cut your losses and move on to the next trade. Turn it into a learning experience that can help you in the future:
1. Analyze your options. Review the decisions you made with fresh eyes after some time has passed. What would you have done differently based on hindsight, and why? Would you have lost less or perhaps nothing if you had acted differently? Answering these questions may help you avoid making the same mistake twice.
2. Regain what you lost. Tighten your financial belt for a while if necessary. You may be able to regain it with a little discipline if the loss is small enough. Recover this amount and try again, taking into account the things you learned for the next time the market becomes unstable.
3.
Don’t let losses define your identity. Keep loss in context and don’t take it too seriously. Remind yourself that many other people out there have taken a hit like you – perhaps even a bigger hit than what you experienced. Loss does not define your identity, but it can make you a better investor if you handle it correctly.
Frequently Asked Questions (FAQs)
How can I protect my retirement savings from stock market losses?
There is no perfect way to avoid losses in the stock market, although retirement accounts generally benefit from the long-term growth trajectory of the market. The best way to protect your retirement accounts from potential losses is to invest in a diversified portfolio of stocks, bonds, and mutual funds. You can also mix in other safe investments like money market accounts and certificates of deposit to ensure that you have some money insulated from large downturns.
How much can I deduct for stock market losses?
The IRS only allows you to deduct up to $3,000 ($1,500 for married couples filing separately) for capital losses in any given tax year. If your loss exceeds this amount, you can carry the remainder forward to deduct from taxes in future years.
What strategies can I use to avoid losing money in the stock market?
There are many different ways to succeed in the stock market, and it’s not something you can learn overnight. Start by paying attention to how global events and market cycles affect stock prices, practice removing your emotions from the equation with small trades, and don’t expect to get rich quickly. It’s always helpful to work with an experienced broker or financial advisor as well.
Thank you for your feedback!
Sources:
Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.”
Source: https://www.thebalancemoney.com/how-to-deal-with-losses-in-the-stock-market-3141314
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