You invest with the hope of building long-term wealth. When the stock market is doing well, it may feel great seeing your accounts increase in value. But when you enter a period of losses, it can be very scary.
No one likes losing money, but negative years of stock market returns are inevitable. And while you probably can't completely bypass bear markets, you can avoid losing money by doing these five things.
1. Set realistic expectations
When you're investing, your expectations of what you could earn should be realistic. And sometimes, measures like average rates of return can be misleading.
For example, if you invested in large-cap stocks between 1926 and 2020, you would've earned an average rate of return of 10.2%. And if you earned this rate of return over 30 years, $100,000 invested would've grown to $1.84 million.
But during that same time period, you would've earned a high of 54% in 1933 and a low return of -43% during 1931. If you invested for the first time during a year of losses, it could make you wary of investing.
Understanding that your returns won't be linear but instead, an average of positive, negative, and flat returns is important. And understanding this may help you withstand the bad years.
2. Know the difference between a realized and unrealized loss
When you look at your account balance and see that it's lower than it was the month before, it may feel as if you've lost money. But the numbers you see on your statement or when you log in to your account are called unrealized losses or gains. These numbers change for better or worse throughout a day of stock market activity and are only considered actual losses or gains when you realize them by selling your holdings.
For example, if your account balance was $10,000 last month and you experienced losses this month, it may now be worth $9,000. But you would only lose money in reality if you sell this investment before it gets back to its original value. Over the long term, the stock market has always increased in value, and your investments should, too, as long as you stay invested.
3. Have an appropriate time horizon
How soon you need your money could impact how well you keep your money invested during stock market crashes. If you won't need your money for 25 years and you suffer a 30% loss, you may shrug it off knowing that your account value could return back to that value in a few years. But if you plan on using the money next year, you may panic at the idea of losing any of it.
Before you invest one penny, think about your time horizon. And the closer it is, the more conservatively you should invest. Without the threat of missing your goal looming over your head, losses may not seem so devastating, and you'll be less likely to give up on investing due to a short-term drop.
4. Control emotions
Controlling your emotions is no easy task, and when you're losing money, it can feel like it will go on forever. But declines have never lasted forever. Learning how you can control your emotions when you're feeling this way can be the difference between experiencing subpar returns that lag benchmarks or keeping pace with them.
When you feel as if the sky is falling and it seems as if there's no end in sight, revisiting stock market corrections of the past can be helpful. Even during some of the periods of the most extreme losses, investors who stayed the course often recouped their losses within a few years. From 2000 through 2002, if you'd invested only in large-cap stocks, you would've lost about 38% in total. If you had $100,000, it would've decreased to around $62,000. But by 2006, you would've regained all of your money and been ahead slightly..
5. Invest in line with your risk appetite
How do you feel about volatility? Do you barely notice it and realize that it's a normal part of a market cycle? Or does it make your stomach drop every time it happens?
You can earn more over the long term if you have more aggressive investments, but in a year of losses, these types of investments could also lose more money. And if the losses seem too big, these investments may be too risky for you.
If this happens, staying invested may be harder. Making sure that you're invested in line with your risk tolerance can help you prevent this. You should also find an asset allocation model that suits your appetite for risk, even if it yields a lower average rate of return.
Investing should help you meet your goals instead of putting you further away from them. While your account value increasing or decreasing regularly is normal, you don't have to lose money. And controlling your fears, making sure you hold suitable investments, having realistic expectations about how your accounts will grow and the time frame in which those gains will happen can help you avoid it.
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