With stock markets riding the escalator up-up-up in recent years and then taking the elevator down these last couple weeks, here are a couple of principles to help us keep both gains and losses in context.
Think Percentages Rather Than Absolute Dollars
I’ve noticed that some people focus on the specific dollar amount of fluctuations in their portfolio. Particularly if they’re receiving weekly email updates on their account balance. And I get it, especially for those of us who live a modest lifestyle…if we see our portfolio drop $6,000 over a week or two, we’re thinking “hey, that’s almost two months of living expenses.”
But the real question is: $6,000 in relation to what?
Consider the meaningful difference (in decline) between these two hypothetical portfolios:
- $150,000 portfolio declines $6,000 to $194,000, that’s down 4.0%
- $600,000 portfolio declines $6,000 to $594,000, that’s down only 1.0%
The concept is actually similar to recent media hyperventilation over the Dow’s 1,175 point loss on February 5. It was trumpeted as the largest daily point loss ever, which is true. But on a percentage basis, it ended the day down “only” 4.6%. That doesn’t even qualify for the Dow top 20 daily losses, which includes October 19, 1987 down a heart-stopping 22.6%!
It’s not Real (Realized) Until You Sell It
I have a client who sometimes jokingly asks: “But when will it [their portfolio value] become real, Larry?” She gets it.
Some investments (or at least the price at which you bought) are bad and should be dumped. But provided your underlying investments are good, fluctuations in portfolio values can simply be paper losses and paper gains. Or put more accurately with today’s technology: it’s just fluctuations in digital bits and bytes that represent values in your account.
Think about your house. The fair market value (FMV) fluctuates according to where interest rates are headed, housing supply and demand in your region, and so on. If you bought your house for $250,000 and it’s now worth $500,000, you may feel $250,000 wealthier but you’d have to sell it (and find other housing) to actually realize that gain.
Financial assets are similar, it’s just that you can easily buy and sell them any moment of the trading day and their prices move more rapidly. Your portfolio’s gain or loss doesn’t become “real” until you sell or exchange the investment and lock in that gain or loss.