On Paper Gains and Paper Losses

The stock market has had a breathtaking run over the past 8 years. Since its low point in March 2009, when the S&P 500 hovered around 686, it has gone up about 250% in this 8-year bull market. Investors who rode out the financial crisis now have portfolio values as large as they’ve ever been. Even better, physicians who finished residency in 2008-2009 have been continually investing in a rapidly rising market.

This bull market will one day end, and we will experience a severe correction. We may even soon experience a “bear market,” a term defined by the financial media as a 20% decline from the previous high. CNBC and Bloomberg will tell us the market is falling in giant text across our television screens, luring you to stay on the channel and watch the misery of the New York Stock Exchange floor traders.

Most Of Us Are Sitting On Paper Gains Right Now

It’s easy for all of us, myself included, to look at our 401(k)s and feel like we are really rich right now. So long as you weren’t following the advice of a billionaire hedge fund manager who said to not “be so frickin’ long” in 2014 and then predicted a stock market top in 2015, you are doing pretty well.

But the reality is that it’s very easy to become fixated on paper gains and losses on our investments. By counting your investment gains now, you are setting yourself up for panic and anxiety when the stock market does experience a correction.

Past market performance is not a predictor of future market returns, and how the market has done in the past has little correlation with how it will do in the future. Just as a gambler might think that future roulette wheel spins are correlated with the past spins, many investors think that the recent rise in the stock market means that it can’t rise any further. It can, and we could just as easily be in the middle of a multi-decade bull market as we could be at the end of the bull market.

The Stock Market Has Done Really Well (Or Not, Depending on How You Look At It)

Investors can choose to look at the glass of market returns as half-empty or half-full. You can do this by cherry-picking the time horizon to calculate market returns. For example, some people have chosen the high point of the stock market in 2000 to benchmark the returns of the S&P 500. Using 2000 as a starting point, the S&P 500 has only risen about 2.7%. On the other hand, if you take the 2009 low as a benchmark, the S&P 500 has risen 16.0%. Depending on when you invested your money, your returns could be very high or very low.

Fortunately, most investors contribute their money slowly over time. It’s the nature of saving a percentage of your paycheck each month. Because we end up buying our investments at many different time points, you derive the benefits of dollar cost averaging. Dollar cost averaging helps smooth out your investment returns by allowing you to buy at the highs and the lows of the market.

Stock markets rise and fall, but over time your actual returns begin to approach the expected return of the market. It’s just the law of large numbers at work.

Dealing With Paper Losses

When the stock market has corrections, people tend to worry about the losses in their portfolio.

I remember hearing some physicians lament a mini-panic in the stock market (something like a 5% drop over a week) and be counting the tens of thousands of dollars they had lost in a week.

Typically, investors will compare their current portfolio with the highest value of their portfolio in the past. “My portfolio was worth $1,000,000 three months ago, and now it is only worth $900,000. I’ve lost $100,000!” What they neglect to realize is that their portfolio was worth $500,000 five years ago and that they are still doing really well in the stock market.

Here are three ways to reduce anxiety about paper losses in your portfolio:

1. Pick a more optimistic time horizon

One simple way to combat this tendency to panic about losses is to simply look at a different time horizon. Instead of picking the market top to measure your losses, pick a recent market low and see how well your portfolio has done. This will help you realize that a market correction is simply a blip on the long-term upward trend of your portfolio.

2. Don’t look at your investments very often

Another way to reduce anxiety about the market is to not look at your investments very often. I rarely check the balance of my portfolio, and I have little idea what my investment returns actually are. I am confident in my investment plan, and I’ll stick with it whether the market is rising or falling.

If you check your investments frequently, as I used to, perhaps you’ve had the experience of opening an account that’s not part of your main investment portfolio. Perhaps it was an HSA or 529, or maybe a 401(k) that doesn’t have a good website to check your portfolio balances. When you look at your account statement after a few years, you’re shocked at how much it’s grown while you haven’t been looking. Much like the news or politics, you can’t control your market returns, so why follow it and get bent out of shape over it?

3. Convert paper losses into “actual” losses with tax-loss harvesting

When the inevitable correction occurs, don’t forget to take advantage of any tax-loss harvesting opportunities that may appear. Since you can only take a $3,000 deduction each year on stock losses and any remaining loss is carried over to the next year, some investors are still taking their annual $3,000 deduction from losses harvested during the financial crisis. When selling shares at a loss, be sure that you follow IRS guidelines to avoid performing a wash sale.

And if you don’t check your investments often, don’t worry, you’ll know when to tax loss harvest. When financial news becomes front page news, it’s when the stock market is falling. When that happens, you’ll know it’s time to do some tax loss harvesting.

Conclusion

Don’t get into the habit of counting your paper gains and losses. You’ll cause yourself unnecessary anxiety and it may throw you off your investment plan. How the market moves in a day, a month, or a year should not change how you invest. In medicine, you don’t order a test if it won’t change your management. Why check the market if it won’t change how you invest?

What do you think? Are you sitting on a lot of paper gains right now? How often do you check your investment returns? Do you want to check them less frequently?