When someone claims to have amazing long-term stock gains you know what else they have? Losses.
But investors hate losses!
Actually, it’s a common human trait. It’s been said the pain of loss is two times as powerful as the joy of gain.
In other words, a stock you bought that quickly rises 50% feels wonderful. You walk down the street with your chest puffed out. Your friends ask for investing tips. Your spouse thinks you’re brilliant.
But staring at a stock you bought that dropped 50%? Well, that feels terrible. Like you lost 100%. Everything.
Ironically, losing money is exactly how investors build long-term wealth. It’s required for gains.
I have no problem taking a 50% loss here and there. I experienced it during the financial crisis in 2008. I’ll experience it again.
Of course, I don’t like staring at a loss. In fact, I wish I never had one. But I accept them as part of building wealth. Why? Because the mindset that allows you to lose 50% is the same mindset that allows you to gain 500%. Most investors will never gain 500% on anything because they’d never invest in a way that they’d lose 50%.
They’re always selling.
After a stock goes down they sell. “I got out at breakeven.” And after a stock goes up they sell. “You can’t go broke taking a profit.”
Their adopted maxim is “don’t lose money,” but if you’re investing in great stocks, and expecting to hold onto them for many years, should the day-to-day or year-to-year price fluctuations even matter?
Here’s an admittedly cherry-picked example.
Netflix was one of the best-performing stocks from 2010 through 2019. It increased 4,224%, turning a $10,000 investment into a life-changing $432,444.
It’s easy to wish you bought Netflix in 2010, but would it have made a difference?
- In 2011 it dropped 79% from $42.68 to $8.95
- In 2012 it dropped 58% from $18.46 to $7.69
- In 2014 it dropped 35% from $69.20 to $45.21
- In 2015 it dropped 37% from $130.93 to $82.79
- In 2018 it dropped 44% from $418.97 to $233.88
The stock has been a nightmare to own. It suffered five separate drops of 35% or more. Dropped more than 58% twice. More than 79% once.
Most investors can’t stomach those losses. They would have sold.
But volatility is the nature of the stock market. Whether you’re investing in stocks like Netflix or broad-market index funds you’re going to spend time losing money. Some days it’s a small amount. Others it’s huge. But it’s how you react to losing money that ultimately determines your gains.
Maybe a simplistic way to think about all this is to start with a $100 portfolio split between two stocks.
The first stock goes up 50%. The second goes down 50%. You’re left with one stock that’s worth $75 and the other $25. They cancel each other out.
But investing has little to do with wiping out 50% losses with equal gains. It’s about building wealth.
So what if the first stock drops a stomach-churning 90% and the other skyrockets 140%? You’ll see this is okay. The losing stock becomes $5 and the winning stock $120. That’s a total of $125 on $100 invested. A 25% annualized return.
The same concept applies across multiple years.
Say your $100 portfolio went up 40% last year and then drops 10% this year. At the end of last year it was $140 but it’s down now to $126. If you’re like most investors you’ll be sitting there feeling terrible, thinking you lost 10%, and wanting to sell.
But in reality, you still gained 26%. So who cares?
I know it’s hard to look at investing this way, that to gain money requires losing it, but that’s how small fortunes get built.