Advised Podcast Ep 005: Understanding Investment Losses & Making Better Decisions

Investor behavior is the number one reason for investment underperformance. In today's episode I discuss a new way to view your investments and how to contextualize your losses (and gains). Having a basic understanding of how you're invested, and WHY you own certain positions goes a long way in making the right decision when times are tough. Not having an investment philosophy that you understand and believe in, can leave you stressed and unsure what to do. That is the EXACT time when people make the wrong moves, negatively impacting them for years to come. Successful Investing can be SIMPLE, but it's definitely not EASY. 

Listen above or read the transcript below, and let us know what you think of the episode!

Rick Luchini (00:00):

You might be surprised to learn that the majority of your past investment losses could have been avoided and it's actually something you have more control over than you realized. Today we're going to discuss the importance of contextualizing your investment losses and your gains and how doing so will help you make better decisions leading to better returns.

Intro (00:25):

You're listening to advise with Rick Luchini.

Rick Luchini (00:29):

I hear it all the time. I lost $3,000 last month. I lost $20,000 last quarter, last year, 152. It doesn't matter what the number is, and even though I know what they mean, anytime I hear that, I always make sure to correct and say you didn't lose anything yet. You see, when the market goes down, you still have the same amount of shares that you had the day before. In the case of dividend paying stocks, sometimes you have more, but when you look at your statement or your account online, the amount of dollars has gone down sometimes in a big way, and that can be scary, but these are called unrealized losses and it's just an accounting of what you would lose or gain should you choose to sell everything today. So I'm going to sell everything. I'm going to close my account out, I'm going to pay the taxes owed. I'm going to bury it in the backyard. I'm going to buy that boat or beach house or farm or whatever the hell is your thing, but you only actually realize those losses when you sell something. Now, I know what you're thinking. That sounds like a glass half full. Either way, my account's down Rick, but stay with me here because this is actually really important. See, if you have a sound strategy that you believe in and you're investing for the long term, which most of you are,


How exactly do those unrealized losses affect you and I should say affect you negatively because there actually are some strategies around tax loss, harvesting and things like that where you can take advantage of them. But for the purposes of this conversation, how do those short term unrealized losses affect you? They don't affect you unless you react to them. That's why it's so important to understand how your strategy works, what your investment philosophy is. If you don't have one, get one because once you believe in something, you have a long-term strategy that makes sense. You won't be as likely to react to these short term unrealized losses because when you do that, you actually realize the loss, you changed the strategy, therefore rendering it useless, and then want to come back when things are good and just plug right back in. But the strategy should have the short-term volatility built in. It already knows those things are going to happen. It is accounted for that, and if you make changes in the middle of it, it's actually no longer the strategy that you agreed to. It's this new thing where you are in control and unfortunately making bad decisions. This is common. This is the majority of people who underperform the general stock market,


Let alone a well-built portfolio. Just even the general stock market. The majority of people underperform not because of access, not because of conspiracy, not because of government. It isn't because of Wall Street, whatever. You view that as the big bad wolf's because of behavior, bad behavior, and it's driven by emotions and it can be controlled with knowledge, with knowing how markets react, with knowing how they have reacted in similar situations in the past. But Rick, I don't do this myself. I pay somebody to worry about this. I don't want to worry about it. Then stop worrying about it. If you're paying somebody to manage your portfolio and they have articulated to you how and why they're doing that good, if you believe in that strategy, then stop worrying about it. But if you are worrying about it, then you need to educate yourself so that when you make a decision, it's the right one. Let me put it another way. At the value of your house dropped 20% next year, would you care? Think about it for a second. For most of you, the answer is going to be no because you have no intentions of selling it anytime soon.


So then why are we panicking when our 4 0 1 k drops 20% and we still have 15 years before we retire? The only difference between those two scenarios is that you are constantly reminded on paper and on a computer screen and now on your phone of how much your four oh one k your investment account is worth today and every single day, and no one is sending you a statement showing you the value of your home. I can assure you if they did, you would see that that fluctuates as much or more than your investments. You just wouldn't care. You say, stop sending me this. I have no intentions of selling my home, and if I did or when I did, it will be so far in the future that the number on this piece of paper means absolutely nothing, and that is exactly the mentality that you need to start looking at your investments through. That does not mean neglect your investments. No, it means build a strategy that you believe in based on a sound investment philosophy, and then let that thing happen. Let it do its thing and don't freak out in the short term. Use the short term number to project future numbers during your planning. Yeah, are we on track to have enough? Are we saving enough? Those are the things you should be worried about, not what the stock market did today.


Now, I understand there's folks out there that need to spend money in retirement or major purchases they need to sell, and when the market's down that could result in realized losses. I get it, and that's where a sound strategy comes into play. You can plan for that. I'm not going to go into the details of how to build a retirement income plan. We can do that another time, but assume you have that plan. Okay?


Please understand this. If you're approaching or currently living in retirement, you do not spend all of your money the first day that you walk out of work for the last time, you should still have a 20 to 30 year investment horizon. Yeah, you're going to spend some money each year and that should be planned for, and the bulk of your portfolio is still in it for the long term. Yet I see a lot of investors and still firms acting like retirement is some endpoint to start slowing down towards and to finally come to a screeching halt of Uber conservative, it's a huge mistake.


There's a lot of missed opportunity and you are putting a lot more stress on yourself and on your plan because you have to save a hell of a lot more money if you're going to slam on the brakes and then use that money for another 30 years than if that money continues to earn for the next 30 years while you spend it. Another very common way that investor behavior is altered is the concept of extrapolation. This one's simple. If my account went down 5% last month and it went down 5% this month, well then it surely is going to go down 5% next month and so on.


So why not just stop the losses? Now, this is very common misunderstanding and leads to a lot of realized losses and huge mistakes and missed opportunity. This is not how the stock market works, and it's almost always the exact wrong time to sell and go to cash or get more conservative because you just experienced some pain. The pain's likely almost over. You've experienced the worst of it. You've already gone through the hurt. You did the thing, and now instead of staying put and experience the good, you lock it in, stop all stop. It's almost always the wrong time and the results of you locking in those losses and then combining that with not experiencing the gains that can be a setback that lasts decades. You can't get that time back, and it's so easily avoided by having a strategy that you believe in and sticking to it.


And I don't say that lightly. I understand what it feels like to see your account go down. I experience it with my clients not having a sound investment philosophy that you believe in creates a self-fulfilling prophecy. If you don't have confidence that the account's going to come back up, you likely will never give it enough time to find out if it would. So the next time you look at your investment account, I challenge you to view it in a different light. Pretend it was the value of your home or maybe the 69 Camaro you have in your garage, or the Harley that you've vowed to never sell, or whatever that important thing is that you're going to hold onto until the day you die. View it as something that's not being sold today and then you'll be begin focusing on the account's future value, and that is a much healthier way to plan and to live your life. Thanks for listening.

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Content Disclosure: Luchini Financial LLC is a registered investment advisor. This content is provided for informational and educational purposes only and is not intended to be personalized investment advice, nor a recommendation to buy or sell any investment. Luchini Financial works closely with each client to gain a full understanding of their unique situation prior to rendering advice. The information contained herein is derived from numerous sources, which are believed to be reliable, but not formally audited by Luchini Financial. Information may include statements which are time-bound and subject to change without notice or opinions, which may not come to pass. Please consult Luchini Financial with any questions.

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