The reality of loss: it only becomes real when you sell

Rumi Mahmood


3 min read

I don’t like seeing the value of my portfolio going down. I don’t like it one bit. And I’m sure neither do you.

At times like this the fear, the alarm, the annoyance – they are visceral. A 5% drop, a 10% drop. Where does it end?

The fact of the matter is, nobody knows. We won’t insult your intelligence and pretend to be soothsayers. But what we can do is learn from the past and use prior experience to help us behave intelligently in the future.

What’s happening?

Current market conditions feel unsettling because we stand in the eye of a storm. Global stock markets are in a rattled state because of the spread of the Covid-19 coronavirus, which is causing slowdowns and disruptions in activity. In this state of market sell-off, with portfolio values falling, many people’s gut response is to engage in damage control, to limit losses.

But is this the right response?

Think about it this way. If your portfolio has gone down, this fall in value is not a confirmed loss – not yet anyway. It’s a potential loss, based on the sum value of your holdings at their current market price.

It becomes real, and confirmed, only if we execute the decision to sell the assets and withdraw our money. Only then will the loss become crystallised, both in time and in our pocket.

In difficult times, it’s easy to lose sight of this. But don’t forget that as well as moving down, markets do move up. That’s inherent in the meaning of that uncomfortable word, volatility. Over the long term, history shows us that markets tend to increase in value. Remaining invested strongly reduces the probability of confirmed losses.

Looking back over half a century of data

Data on global developed market stocks over the last 50 years shows us that the probability of losing money on your investment goes down the longer you stay invested. Look at the chart below, which is based on data from 1970 to 2020. See how the green line falls over time. What this shows is that, no matter when you entered the market during the period, long-term investing drastically decreased your chance of losses.

 

Source: Macrobond; MSCI World Equity Mid and MSCI Large Cap Total Return in GBP, 1 January 1970- January 2020

 

Even looking at shorter periods, we see that by and large, staying invested and focused on the longer term yields a better outcome. Take the S&P 500 index of the US equity market over the last 20 years, for example. The maximum potential loss (drawdown) one could make in each year looks bad – they are the red dots. But the maximum potential gain over the calendar year is always preferable to selling after the drawdown, see the green bars. In many cases, the full-year return was positive despite a large drawdown during the year.

 

Source: Bloomberg – S&P 500 Total Return

 

If you’re wondering what kinds of events caused all those drawdowns, the following chart shows some of the incidents that have affected the S&P 500 index in the last ten years.

 

Source: Stockcharts.com – S&P500 Total Return

 

You have the power

This kind of analysis does not take away from the stress we feel in the moment. Nonetheless, it’s important to put short-term changes into perspective. It isn’t over until it’s over. Losses aren’t losses until we sell, withdraw and confirm them. Although it may not seem that way, the power is always with the investor, because a loss isn’t real until you make it so.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.

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Rumi Mahmood

Rumi Mahmood is an investment analyst here at Nutmeg. He has two years’ industry experience and joined in early 2017 from the Bank of New York Mellon, where he was an analyst in Global Securities Operations. Rumi holds a masters degree in Engineering from the University of Manchester.


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