The question on everyone’s mind during any correction is:
“Melissa, my portfolio was worth $300,000 two weeks ago, now it’s worth $200,000. Shouldn’t I sell now to avoid “losing” even more money?”
No, definitely not. Your portfolio is made up of shares of investments, not dollars. The value of those shares change constantly and, over time, generally increase in value (this is known as Growth). When the values are up, we feel prosperous and happy. And when the values are down, we experience what feels like Loss, which quickly turns to fear and panic. These emotions set in place our fight or flight instincts and, for the most part, we choose flight. People sell their investments and the fear based momentum begins to plunge downward. BTW, the same instinct that leads people to hoard toilet paper, is the same one that leads them to sell their investments. Maybe I missed the memo, everyone else is doing it, I guess I should be too.
Here’s how that directly and detrimentally can effect your financial health:
Let’s say you own 10000 shares of a mutual fund, we’ll call it Sweet Money fund (SWEETX) and the price of one share is $30, making the total value of your portfolio $300,000.
10000 shares X $30/share = $300,000. Portfolio value on this particular day
News of a pandemic starts swirling and in a matter of days, because people are selling and driving down the price, your shares are now worth $20 and your total portfolio value is now $200,000.
10000 shares X $20/share = $200,000
Things are increasingly chaotic and the volatility continues over the coming days and we see huge swings in market prices which leads to more panic and emotional investing. But, and this is most important message to understand, you still have your 10000 shares.
But, because your eyes only focus on the portfolio value, you decide to cut your losses and sell all your shares when they hit $20. Finally, you feel a twinge of relief and you’re feeling pretty confident that you’ve dodged a bullet and ‘saved’ yourself from ‘losing’ even more money. After all, there’s a very good chance that the share price could (and likely will) drop even further. Well, you’re right about that, most likely. But only in the short term.
So now you have your $200,000 dollars (not shares). And you decide to keep that money in a bank or under your mattress until the storm subsides and the prices stop going up and down so dramatically. And over the course of the next several weeks, months and, perhaps years, as the pandemic gets more under control, we start to see recovery and, low and behold, SWEETX is once again trading at $30/share. At this point, your convinced the crisis has been contained and you buy back your shares. Here’s the problem:
You’ve got $200,000 and each share is worth $30. Now your $200,000 will only be enough to buy 6667 shares (6667 X $30 = $200,000). Ouch!
If, on the other hand, you did not sell, you would still have all 10000 shares and your portfolio would be worth $300,000 again. (10000 shares X 30/share = $300,000). And when the prices rise to $35, $40, $45 over the next several years, your 10000 shares will then be worth:
$350,000, $400,000 and $450,000 respectively.
And your 6667 shares at the same prices, ($35, $40, $45), will the be worth:
$233,345, $266,680, $300,015
share before you recover your what you think you “lost”. And you still only have 6667 shares as opposed to 10000 that you started with.
And this is not even the whole picture because you also make income from your shares in the form of interest, dividends and capital gains so your portfolio now, after resisting the urge to sell low, is filled with even more shares because you used that money to reinvest and buy more shares (lots more shares when the prices drop low!). The lower they go, the more shares you’re able to buy.
Unless you SOLD all your SHARES and have only DOLLARS in your pocket. Because when stock prices are falling, so are interest rates on cash. With interest rates near zero (like right now), you can expect to get a similar rate in your savings accounts. The technical term I use (and many of you have heard this before) to describe this interest rate is: “point oh nothing”. Good luck recovering your losses with that interest rate. Compared to the percentage increase in the stock market over time…well, there is no comparison.