Losing, gaining in the market

Having discussed portfolio killers and some strategies for wise investing, take a look at your accounts. Do you find that you seem to be dumping lump sums into the market only to see the market go down? Are you investing little by little? Or are you trying to time the market? An investor went to see his advisor  the first time during the summer of 2000. He joked that he had bad luck because, he said, every time he and his wife invested more money in the market, immediately it would go down. Even though his outlook was that the market would go down after his money was invested (and, for the record, the market did go down), he continued to invest his money. He knew, as all wise investors do, that to not be invested is a far greater mistake than to invest at the “wrong” time. No one knows what the market will do for sure.

The experts can speculate all they want based on prior performance, but that doesn’t mean that the market is going to follow its past trends. If you are afraid that once you invest your money the market will go down, try using the DCA (Dollar Cost Averaging) method which was discussed in last week’s column)  And if the market does go down, hold your position. There is a difference between your share holding value going down and losing money. Many people don’t understand this concept. Basically, when the market goes down, equity investment values go down. To most investors, this is troubling. To others, it’s not. This is why: The loss is only on paper. There are people who will call their advisor during a down market and him/her that they are losing money and that they don’t want to lose any more. What they fail to understand is that there is no real loss until they sell, or liquidate, their position in the security.

Here is an example. You purchase $40,000 of the XYZ Value Fund. After a few quarters of positive growth, you receive your statement and see that your investment is now worth $45,000. However, then the market begins to decline. Your next statement shows your investment value at $42,500. This is still a net paper gain of $2500 from your original investment. But then the next quarter shows a drop of $4000, bringing your investment value down to $38,500. You have a paper loss of $1500. This isn’t an actual loss until you sell your fund. If you were to cash out of your position at that point (thus, receiving $38,500 for your fund), you would have an actual loss of $1500. But if you don’t, and you hold your position in the XYZ Value Fund, you have only a paper loss. This is what many people don’t understand, and is one of the reasons why money is such an emotional thing. For this reason,  during a declining market, you should not look at your at your holdings on a regular basis. Even during a bull market, when account values are consistently going up, this isn’t a healthy practice.

During downward trending markets, you may  say that you have lost X amount of money. By looking at your account statements, you know exactly how much your portfolio has declined. However, some investors arrive at a number that may be more than what the actual decline is. Why is that? The tendency is that when calculating the loss, people use the highest figure to the present. For instance, an investor says that she had lost a substantial amount of money, when in fact she had only lost $5000. When she calculated her loss, she used the account value from the peak of the T& T Composite index. She didn’t account for what her original investment was. She took her peak account value and subtracted the current value from it. Unfortunately, she’s not the only person who does this. When assessing your account positions, it’s vital that you remember where you started.

Just because your accounts reached $1.2 million and then dipped to $800,000 doesn’t mean you lost $400,000. If your initial investment was worth $750,000, then you still have a net paper gain of $50,000 Notice it is a  “net paper gain.” This is just like the paper losses. The gain isn’t really your money until you cash out of your position. It’s merely a rise in your account value. If you put $750,000 into the market and then sold off all your positions for a total of $925,000, then you have made $175,000. If you don’t, and you hold your position, then the increase in the account value isn’t an actual gain; it’s just a paper gain. So, the next time you look at your account statement and see a loss, don’t overreact. It’s only on paper until you do something about it. Likewise, if you see an increase, don’t go out and buy things based on your statement. You have to liquidate your position before you can actually realise a loss or a gain.