The Misleading Comfort of Investment Sayings
There’s a common phrase in the realm of personal finance and investing that suggests “You don’t lose money until you sell”. However, this saying is more than just misleading—it’s outright incorrect. It’s a phrase that might offer solace to those facing financial downturns, but when it comes to the reality of investing, it simply doesn’t hold water.
Psychology vs. Reality in Investment Losses
Why does this phrase persist among investors? Primarily, it serves as a psychological balm and a deterrent against panic selling. The idea is that if you haven’t cashed out, you haven’t realized the loss. While this may encourage investors to stick with a long-term strategy, it skews the true nature of financial losses.
Breaking Down the Real Loss
Consider a scenario where you own a stock index fund worth $100,000, which then drops to $78,000 in a bear market. Despite what the old adage suggests, you have indeed lost $22,000. The value of your investment has decreased, regardless of whether you sell or not. The only variables not accounted for in this equation are taxes and inflation or deflation.
The Long View: When Losses May Not Sting
For some investors, particularly those with a robust long-term plan, these losses are less concerning. Their focus is on the eventual selling price and the overall growth of their investments over decades. Volatility is expected, and temporary downturns are viewed within the broader context of future gains.
The Consequences of Selling
Selling does more than just crystallize losses or gains. It also locks you out of potential future appreciation and dividends. Moreover, it introduces tax implications, which can either work in your favor through mechanisms like tax-loss harvesting or against you by realizing capital gains.
The Risks of Holding On
However, the saying can lead to detrimental financial behaviors. Investors may anchor to an investment’s peak value, skewing their perception of wealth and leading to poor financial decisions. Additionally, holding on to poor investments in the hope they will rebound can result in further losses, particularly if the investment doesn’t align with a sound financial strategy.
The Dangers of Anchoring and Bad Investments
Using the phrase to justify holding onto a bad investment is perhaps the most problematic. For example, if an investor purchased Tesla stock at its peak and it has since plummeted, holding on due to the belief that they haven’t “really” lost money can be financially ruinous. This false sense of security can prevent them from making the wise decision to sell and mitigate further losses.
Why Tax-Loss Harvesting Matters
In a taxable account, clinging to a declining investment makes little sense. Tax-loss harvesting should be employed to offset taxes while maintaining a similar portfolio. Believing that losses aren’t real until the sale can deter investors from taking advantage of this beneficial strategy.
Understanding Real Losses in Investing
Ultimately, the notion that “You don’t lose money until you sell” reveals a fundamental misunderstanding of investment dynamics. While it’s not necessary to confront those who cling to this belief, guiding them towards a clearer understanding of financial losses could be a beneficial move. The bottom line is that losses in the value of investments are real, whether or not the assets are sold, and acknowledging this is key to savvy investing.
Join the Discussion
What’s your take on the matter? Do you consider unsold investments as a loss or not? Share your thoughts and contribute to the conversation.
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