Recovering Investment Losses: A Comprehensive Guide

If you’re not sure what to do with unrealized losses in your investment portfolio, these are the recommendations from experts.

Investors must carefully consider a number of factors related to their psychology, portfolio characteristics, risk tolerance, investment objectives, time horizon, and tax situation before determining whether to cut losses or double down.

Encouraged by declining inflation rates and strong earnings announcements from top large-cap tech companies, the U S. stock market roared back to life in 2023. By May 19 market close, the benchmark S 2%, but the tech-and-growth-stock-heavy Nasdaq composite has increased in 2020. 9%.

However, some investors who lost money in the 2022 bear market are probably still holding onto unrealized losses in their investments. By 2022, the S 4% and 33. 1%, respectively, as a result of aggressive interest rate hikes from the Federal Reserve and high, sticky inflation.

The reason for this is that there is an asymmetric relationship between investment gains and losses in mathematics. Bigger gains are required to recover from smaller losses.

For instance, the 19. 4% decrease in the S 1% gain to break even from. The larger 33. A 1% decline in the Nasdaq would necessitate a nearly 20% gain in order to break even. Since the markets haven’t recovered all that much, many investors are still losing money.

Although the Reddit meme stock community may support “diamond handing” a loss—a term that alludes to the propensity to cling to a declining investment—the question of how to handle a loss in the stock market isn’t always cut and dry.

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Investors must carefully consider a number of factors related to their psychology, portfolio characteristics, risk tolerance, investment objectives, time horizon, and tax situation before determining whether to cut losses or double down.

Here are some professional opinions and advice on how to bounce back from a stock market loss:

When to Buy the Dip

The best time to buy the dip is when an investor’s portfolio is already highly diversified. To further spread risk, this should ideally include a mix of stocks from various market-cap sizes, industries, and geographical areas in addition to a portion allocated to bonds, cash, or even alternative investments like real estate.

Although certain assets might not withstand a market downturn, investors who possess hundreds or even thousands of distinct assets with diverse risk and return attributes are no longer concerned about this issue. These investors can buy the dip with impunity as long as they have the money and the risk tolerance, knowing that their portfolio will hold up.

Maintaining a long-term perspective is key here. Nilay Gandhi, senior wealth advisor at Vanguard, says, “It’s important to keep in mind that market downturns arent rare events, and most will experience at least a few during their lifetime.” “Although bear markets can be painful, numerous bull market upswings throughout history have been more substantial and frequently prolonged, resulting in long-term gains for investors.” “.

Here’s an investing proverb to keep in mind: “Time in the market beats timing the market.” Robert Johnson, a finance professor at Creighton University, emphasizes the significance of this by stating: “In the 20 years from Jan. 2, 2001, to Dec. 31, 2020, your total [annualized] return was reduced from 7% if you missed the top 10 stock market days. 47% to 3. 35%. “.

A market decline can also be an excellent way for investors with dry powder to deploy to buy stocks or bonds at steep discounts. This works particularly well with mutual funds and exchange-traded funds (ETFs) that track the broad market index, as they provide far more diversification than a single stock selection or industry does.

“If you have extra money sitting on the sidelines, it’s important to add it to your portfolio and stay invested during market downturns,” says Lauren Wybar, senior wealth advisor at Vanguard. “Down markets present a fantastic chance to boost contributions while costs are low or set up recurring contributions to participate at various price points. “.

When to Cut Your Losses

Buying the dip blindly may not be a wise course of action if your portfolio consists of a variety of high-conviction stock selections that have since fallen out of favor rather than diversified funds. For specific stock selections, there is a chance to reduce losses.

Investors should make an effort to separate themselves from sentimental attachments to a stock when determining whether or not to take a loss. This entails assessing your original motivations for purchasing the stock and determining whether or not a reasonable person would do so in the present, considering the available information. Being as logical, cold-blooded, and mechanical as you can (i.e., trying to keep your emotions out of it as much as possible) is the key to success here.

Analyze the company’s financial metrics in comparison to the industry, sector, and overall economic climate as of right now. Pay attention to opposing viewpoints and keep an open mind when evaluating the bear thesis. Try not to label opposing viewpoints as “FUD,” or “fear, uncertainty, and doubt,” right away. Recall that it’s crucial to avoid getting trapped in an echo chamber.

Harvesting tax losses on an investment is another reason to sell it at a loss. Selling positions at a loss below your cost basis can be a smart way to save money if you have capital gains elsewhere in your portfolio and want to offset them. According to Gandhi, “harvesting losses annually can help to reduce any capital gains tax payable or even your taxable income.”

By circumventing the IRS 30-day wash-sale rule, tax-loss harvesting, when done correctly, can even enable investors to maintain their investment. “Sell at a loss and use the proceeds to buy into a similar, but not substantially identical, fund if you want to stay invested,” advises Wybar. In this manner, you can recover your losses and take advantage of gains when the market rises again. “.

For example, investors can sell the Vanguard S&P 500 ETF (ticker: VOO) at a loss, while simultaneously purchasing the Vanguard Total Stock Market Index ETF (VTI).

Investors don’t have to be concerned about missing out on a market rebound following tax-loss selling because VTI and VOO have historically produced nearly identical returns and hold a similar portfolio. Additionally, because of their different underlying indexes, neither ETF is deemed by IRS regulations to be “substantially identical” to the other, which can assist investors in avoiding violating the wash-sale rule.

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FAQ

What percentage do you need to recover loss?

What to do when your investments are losing money?

What to do with a losing stock?

How do you recover lost investments?

How to recover from a loss in the stock market?

Here are some expert insights and suggestions for how to recover from a loss in the stock market: When to buy the dip. When to cut your losses. Behavioral pitfalls to avoid. Buying the dip is most advantageous when an investor’s portfolio is already heavily diversified.

What happens if you sell a stock and take a loss?

Say you sell a stock and take a $5,000 loss in the process. If you’re sitting on a $5,000 gain, suddenly that gain is wiped out from a tax-liability standpoint. And if you’re looking at a loss that will exceed any gains you’re sitting on or planning to take, up to $3,000 in capital losses can be used to offset ordinary income.

Can you write off a loss if you buy a stock?

You can’t simply write off losses because the stock is worth less than when you bought it. You can deduct your loss against capital gains. Any taxable capital gain – an investment gain – realized in that tax year can be offset with a capital loss from that year or one carried forward from a prior year.

How do I deduct stock losses on my taxes?

You must fill out IRS Form 8949 and Schedule D to deduct stock losses on your taxes. Short-term capital losses are calculated against short-term capital gains to arrive at the net short-term capital gain or loss on Part I of the form.