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Ways to Cope and Recover from Financial Loss

This topic can be very broad by its nature, and also what we mean by ‘financial loss’, so let’s narrow it down a bit. There are mainly 2 types of financial losses, a permanent loss or a temporary loss, and while they may ‘feel’ the same to the investor, they’re quite different.

A permanent Loss is as the name implies, permanent, irrevocable and cannot be undone no matter what we do. Examples of this could be just plain fraud (when someone takes your money, say Bernie Madoff) which still happens today and more so on the (sadly) elderly population, or a company you were invested in going completely bankrupt (like Lehman Brothers, Enron or Worldcom) or if a strategy that requires more capital to maintain than you have (like margin or option trading). Those are examples of permanent losses, cannot be undone and we need to be very careful on those type of investments that have such probability of happening.

A temporary Loss is as the name implies, temporary, but in the moment we may not think or believe it is temporary. A temporary loss example is just investing in the stock market and ‘looking’ at losses when the market goes down, especially significantly during times of unexpected ‘stress’. One example is the market drop of about 30% down from its previous peak during the beginning of COVID in February – March of 2020 (for S&P 500 index, see chart below). If invested properly and diversified, an investor that ‘saw’ that 30% or so temporary loss during the months of February, March and April in 2020, was almost back to its previous highs in just a few months. That was a very quick temporary loss, but it could be much longer, example during the 2008-2009 real estate crisis it took almost 5 years to recover and go back to its prior high – still a “temporary” loss but which took significantly longer.

April 2022_Blog ImagePeople “saw” losses which happened to be temporary

The phases of a loss & grief

Understanding the two different types of losses is key to coping or finding ways to manage the perceived loss. Some say, ‘there’s no loss until you sell’, which works with a temporary loss but not a permanent one. Just like any loss & grief, a person experiencing financial loss will go through the 5 phases of grief, those being denial, anger, bargaining, depression and acceptance. My point here is that by understanding the difference between a permanent loss and a temporary one, one may not need to go through the grief of a financial loss if just temporary. Understanding that the financial markets compensate well only because at times there is risk and perceived losses (even if temporary) is key of how the financial markets work, offering no guarantees of a return but rewarding the patient investor really well over the long-term. With a permanent loss and depending on the size of the loss then you may have to go through the phases of loss & grief, no escape on that.

How to have a loss and still move on

The way to minimize losses and associated grief is first to have a plan in place and then manage your expectations from the beginning. One of our first sentences we discuss with our clients about the stock market or investing in general is that every 3-5 years we should expect a 20-30% market drop, we don’t know when but it most likely will happen. Every 20-30 years we should expected an even bigger temporary loss in the market of 50% or so, and shorter term every 1-2 years we should expect at least a 5-10% drop, all of them temporary in nature with recovery well within 3-5 years based on historical past happenings. History may not repeat, but it often does rhyme and over long-terms we get a good idea of what to expect, even though we won’t know ‘when to expect it’. The way to ‘have a loss and move on’ is to have most or all of your losses as temporary losses, and not permanent ones. The way to do such is by diversifying risk, or remove/reduce single stock exposure or if have such exposure to be minimal so that it doesn’t affect much even if you lose it all.

 Identify the cause for the loss, find valuable lessons

But losses and failures in general are the best lessons if you know where to look and how to evaluate them. We learn much more from failing than by succeeding, so even if you do lose or ‘fail’ at a certain strategy you will at the very least learn not to do it again, or even better how to improve on it and make it better. Many people are risk averse and don’t like much losing (well, who does) but looking it from this point of view every loss comes embedded with a very valuable lesson that could be much more valuable than the loss itself. If the loss is early in life or your investing life then you can take the lesson and not repeat it or make it much better in the future when you’re handling larger investment sums. Much better to fail and make a mistake with $1,000 dollars than make the same mistake later with $100,000.

 Start anew with a revised strategy in hand

From the above talk, some don’t learn anything and may be bound to repeat their mistakes, but many learn and it helps them improve in the future. In the investing world more and more, including myself, have improved over our own mistakes and others mistakes, creating every time a better strategy that has better chances to succeed. Without the loss or failure, you wouldn’t really need to improve on your strategy. And specific to investing, more and more people, after making most of their mistakes early in life, move towards diversification and risk management, reducing single-stock investing and heavily concentrated positions.

 Never stop learning

It is hard to lose money, no one likes it, but the learning that comes from it is much more valuable than even if someone told you about the exact mistake before you did it. Many, including myself, say ‘learn from other people’s mistakes’, and while I do there is no experience as learning from your own mistakes. The feelings, the loss, the failure you feel inside make you never forget, especially if the loss is big and that is key in your future endeavors, either those being financial related or not. Losing or failing is not easy, but I believe is one of the best learning processes we have, much better than books or learning from history. Managing your expectations, and somewhat lowering them (even if artificially) is also a good way to keep you on track, expect almost anything and stay the course if you have a good plan. If invested properly, most losses are temporary, unless you make them permanent by panicking, selling early and never coming back on the recovery that always follows.