Psychology of Investing: 1. Dealing with Loss

About the psychology of investing series

This article is part of a companion series to our ultimate investing guides which cover the basics of investing in a variety of asset classes:

Those guides explain how to access those investment opportunities. However, being competent at moving your money is only half the picture.

An experienced investor will appreciate that the psychology of investing has an out-sized impact on investing success.

I have written about whether now is a good time to invest in the stock market, when investors should buy shares and when is the right time to sell shares. The popularity of these three articles tells me that indecision and insecurity feed into our investment decisions more than we’d like to admit.

Rely on your understanding of investing psychology, not the news

In a very uncertain field, it’s natural to seek out reassurances for each key decision you make. However, doing so is a big risk in a media sphere where cynical financial media journalists sometimes produce two articles predicting stock market movements in both directions on the same day.

Gambling on the accuracy of soothsayers, or more accurately – the soothsayer view you happen to stumble upon – is not an educated investment strategy. It relies on little more than luck.

To create a basic investment portfolio that you a) believe in and b) can consistently stick to, you will benefit from an appreciation of the psychological factors that can cause trouble down the line.

This psychology of investing series will comprise six bite-sized articles which will each focus on a single problem (a stressor) or a solution (a mindset). I hope to challenge your views and encourage you to reflect upon how the stresses of investing affect you, and how your portfolio is designed to resist negative urges.

How to respond to investment losses

How you react to losing money is perhaps the greatest single determinant of whether you will invest successfully over the long term.

That’s why I probe into this area in my investment risk appetite questionnaire.

Why it matters:

Startled investors who sell all their holdings after a period of heavy losses will likely be selling at a loss. The days after a market crash usually mark a low-point in the valuation cycle or ‘boom’ and ‘bust.

In other words, our instincts to run away from a losing investment tend to kick in at the worst possible moment.

Even a modest reaction can hold you back

Many investors ‘hang in’ to their investments, but the shadow of the crash still affects their strategy in subtle ways. They reign in future investments. They cancel their regular monthly payment to their investment account. They begin to hoard cash.

This isn’t as unhelpful as disposing of your entire portfolio at a low valuation, but it will still reduce your returns.

The same low prices which cripple sellers create bargain opportunities for buyers. You will miss these opportunities if you stay on the sidelines in a crisis rather than investing as normal.

A sizeable portion of total investment gains you will make will come from the investments made during these difficult, nervy, but exciting periods. This chunk of profit is essential to offset the poorer performing investments you will make while the stock market is at the top of a valuation cycle.

The ‘average stock market return’ figures of 5-8% which you will often hear about, will include the effect of investments made at the rock bottom.

Investing at the bottom isn’t a matter of skill

When we look at historical graphs with the filter of hindsight, we can slip into an assumption that we would have seized the opportunity to invest at the bottom.

However, the twist is that the bottom of the market never feels like it at the time.

Consider this: why would precisely that moment have the lowest price? It must have been the moment that investors hit peak pessimism. The darkest moment in the bleak outlook. Against that backdrop, it would take a strong will and a stroke of luck to conclude that the only way is up!

The only way to intentionally invest at the bottom of the market is to never cease your investing. If you continue your regular drip-feeding regardless of market turmoil, you will ensure that a portion of your money goes in during the golden window of opportunity.

Keep reading: The full Psychology of Investing Series:

  1. How to Accept Losses
  2. The Income Mindset
  3. The Dangers of Exuberance
  4. Keeping your Hobby in its Box
  5. Auto-Pilot Investments

Keep reading

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