That wise investment makes money work to make more money is a widely understood personal finance fact. We invest to take care of future needs after accounting for the impact of inflation that eats away the value of money with every passing year.
Government-backed investment avenues with guaranteed returns typically do not disappoint investors as the maturity amount is always higher than the invested principle. However, in chasing better inflation-beating returns, investors tend to park their surplus with market instruments like shares, corporate bonds, and mutual funds.
Any market-linked investment is subject to market fluctuations and could, at times, generate negative returns for investors. Seeing our investment value running into negative may not be pleasant for most of us. Often, in such situations, we tend to panic and press the redemption button to book losses.
For instance, it is widely observed that after making losses, investors either do not invest again in the same avenue or take longer than usual to come back. Both are hazardous investment behaviours, and one should refrain from emulating either of them.
Investment losses can happen to anyone, no matter how experienced or savvy investors they may be. However, what matters more than staving off all potential losses are the right strategies for recovering from them. So what can you as an investor do to keep your losses to the minimum?
Here are five basic tenets, which, if understood well, can help you manage losses from your investments and keep them to the minimum.
1) Invested sum should be for the long term: Before investing in market-linked products, estimate the amount you will need only after the next 3-5 years. Invest only towards that in the market. This strategy will keep you at peace even if the market value of your portfolio slips below your cost of investment in the short-term.
2) Evaluate Losses: Losses in portfolio value is part and parcel of investing. Any investment related actions — be it booking losses or additional investment — should ideally be based on evaluation of the kind of losses. Typically, there are two types of losses — temporary and permanent. If the investment value is below the principle, there could be various temporary or one-time factors that may have contributed to the losses. If your own research and advice from market experts suggest that decline in value of your investment is temporary in nature and that the value should regain sooner or later as cycle turns, you should stay put.
On the other hand, if losses are due to factors that can’t be repaired in the foreseen future and further fall is inevitable, such losses should be termed as permanent. It is advisable to get out of such investment as soon as possible before the quantum of capital loss increases further.
Factors that potentially result in permanent losses could be a defaulting company, unwinding of businesses, regulatory actions forcing company’s closure, inability of a company to adapt to the fast-changing business ecosystem, among others.
3) Understand the investment cycle: Don’t panic when in losses; rather, stay put. Try to avoid selling shares or redeeming your mutual fund units. Do your research and understand the business cycles of the underlying securities you are invested in. If need be, consult your financial advisor or investment experts and try to understand the fundamentals and the potential of a rebound. This will help you make an informed decision.
4) Purchase more: If you have moderate-to-high risk-taking capacity, consider buying more of such securities to bring down your average investment cost. Averaging of costs during weak market phases immensely helps in wealth creation in the long run. It’s advisable to consider phases of the weak market cycle to invest more. But before that a little bit of research and due diligence always help.
5) Shift Investments: Another way to deal with losses is to shift your investment from the current securities to the promising ones. You may have to book some losses in the process but potential gains in other instruments may be much more than the overall booked losses. This way, you can emerge as net positive in terms of gains.
At times when you are in need of money during emergencies and have no source other than your investments, you have no choice but to book losses. On such occasions, the current valuation of your portfolio does not matter; what matters is that you need funds, and you have to raise the money even if it comes at a loss. In order to avoid such a situation, it is advisable to keep an emergency fund ready. Do not invest this corpus in market-linked products.
Also, have your exit strategy planned. Move your investments from equity to debt in a phased manner as you near your goal. Do not leave it for the last minute. On the contrary, give yourself ample window to do this so that your returns are less impacted even if the market crashes significantly.
It’s worth remembering that your financial behaviour decides the fate of your investments. There are times when you are no longer supposed to manage your investments but your financial behaviour. One needs to strike a fine balance between returns and capital protection in order to create the desired wealth and meet life’s various financial goals.
(The writer is the CEO of Bank Bazaar.com, views are personal)