Face It: You Lost Money Even If You Didn’t Sell
I’d like to address a common investing maxim that really annoys me, the idea that “you haven’t lost anything until you sell.” That’s pure and utter non-sense. If your account value has decreased, you’ve lost money and that’s all there is to it.
The IRS Does Not Control The Definition Of The Word “Loss”
The most common argument I hear justifying this mindset is the fact that you don’t have to pay tax on a gain until you sell for a profit. Similarly, you can’t write off a loss until you sell. People quote these facts to me as though the IRS controls the universe and what they say must be the Gospel truth. People, the IRS rules are arbitrary, meant to allow the government to get their hands on a piece of your income, nothing more. The IRS never intended to co-op the meaning of the English word “loss”.
In order to lose money on an investment, the value of your investment must simply be worth less than the price you paid for it. That’s it. It doesn’t matter if that decrease in value comes in the form of reduced cash proceeds from a sale or lower current market prices. Pretending you haven’t taken a loss just because you haven’t sold is pure self-deception.
Suppose you’re walking down the street and a pick-pocket manages to steal your wallet, which has a crisp $100 bill inside. Have you not just lost $100 simply because you haven’t noticed it’s gone yet? Of course not. You’ve lost the money regardless of whether or not you’re aware of it. It’s simply not there, and ignoring that fact won’t get your money back. The same is true with “paper” losses in the market. Choosing not to acknowledge your loss doesn’t make it go away. You have less money than you had before, be it in the form of cash or depreciated securities or whatever else. It’s gone forever and you can’t get it back. Deal with it.
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Agreed.
I think the original idea is a worthwhile one–don’t sell after something goes down. But to pretend that your account value has not, in fact, gone down is of course nonsense.
“Pretending you haven’t taken a loss just because you haven’t sold is pure self-deception.”
It’s just mental accounting, people make errors like this all the time in either direction. But you can’t redefine what it means to “take” a loss. You “take” a loss when you sell your shares/house/bond when it’s underwater. The current market price for an asset only matters if you need to liquidate it.
Sorry, but Prices are set at the margin. If you (and a bunch of other people) hold a bunch of shares of something “worth” a certain amount, and you suddenly all go to sell them, guess how much those shares end up being worth?
The point is, a gain/loss can be projected, but realizing it means selling. And nobody is holding a gun to anyone’s head to make them sell.
I guess it just depends on what you consider to be a loss. Let’s say I buy $10,000 worth of Johnson & Johnson, which gives me ownership of 1% of the company (this is wildly inaccurate, but it’s just to prove a point). The price that people are willing to pay for shares of J&J then drops 10%, making my investment worth $9,000.
I still own 1% of the company. So did I really lose anything? I have the rights to the same earnings or dividends of the same company. The only thing that’s changed is the market’s perception of its value.
I guess it’s the difference between buying a company as if you were buying the whole thing and holding it forever (the Warren Buffett/Ben Graham style) and buying a company as if you’re going to sell it someday. Yeah, it sucks that the market no longer values your investment if you want to get out. But if you’re buying a business for its earnings and staying power, the market devaluing and revaluing and devaluing a company a million times doesn’t really matter.
I do agree though, that holding onto an investment just so you don’t realize losses is silly. If you see a better place to allocate the capital, you should pull out, whether the stock and risen or fallen in the meantime.
You’re not quite right. If you didn’t sell, you did not lose money.
Here’s the proof. I have $100. I take $10 and buy a music CD, because I believe that the CD is worth at least $10. I now have $90 and a CD.
If I were to turn around and sell it, I would get less than $10 for it. Furthermore, let’s say news has come out that drives that particular CD’s value down to $2.
I still have $90 and a CD. Absolutely nothing has changed.
Now, your argument is essentially that stocks are media of exchange, not assets. In other words, like gold or paper money, the only reason you want them is so you can sell them again later. You’re saying there is no inherent value in the stock itself. I don’t agree with that, but I do understand why you’re taking that position.
The bottom line, though, is that I have $100 and buy a stock for $10, then I have $90 and a stock. Fluctuations in the amount of paper money, oil, gold, chickens, fertilizer, or pretty rocks I can get for my stock is irrelevant, unless I want to exchange my stock for one of those things.
Another thing you are missing: that drop of $10 in price could just as easily be equal to the amount of deflation in the economy, therefore I have lost no buying power.
Fundamentally, your mistake is your focus on paper dollars as the sole method of valuation.
“I still have $90 and a CD. Absolutely nothing has changed.”
Sure it has, your CD has lost value. You may be perfectly ok with your CD losing value because you only care about the music on it, but it is still worth less than it was before.
My argument isn’t that stocks aren’t assets, it’s that ALL assets are a medium of exchange. Cash is merely there to facilitate the exchange, it holds no value on its own.
Joe Light: Yes, I would say you have lost something even if you still own 1% of the company. The market believes the future value of its cash flows has decreased, which most definitely has a bearing on what your 1% share is worth. Saying your share of earnings and dividends are the same in either case is meaningless since we have no way of knowing what those earnings will be (if there are any at all: bankruptcy is also a possibility).
S: I disagree that the standard english definition of “taking” a loss means selling. Languages don’t work that way. There is always an alternate definition and it is impossible to get everybody to agree even on definitions you’d think would be set in stone. I would be willing to bet there is not a single phrase or word in the entire english language with only one definition. So I don’t have to redefine anything.
I understand your point but I actually think your loss (or gain for that matter) does relate to when you sell. Sure my net worth is less now than it was 2 years ago, but I certainly don’t ever say that I lost x amount of money in the market. I would merely consider myself down at the present time. And if I had really lost that money as you claim and it is never going to return, why would I ever keep it in the stock market?
Plainly put, stock gains/losses are virtual gains/losses until you sell.