Recovering From a Bad Investment
So, you made an investment that didn’t work out. The first step is to take a deep breath.
Bad investments can happen. One misstep doesn’t mean you can’t recover your investment. In the long run, it may even make you a more experienced and skillful investor.
An investment, by nature, is some sort of deployment of capital in order to make a profit. Investors should know that in order to make money, they might have to take a risk.
In fact, risk and return are two sides of the same coin. Generally speaking, to have a chance at a higher reward, you must assume a higher risk. Assuming risk means taking the chance that you might lose money. There are no free lunches.
Investments gone awry can take many different forms. It can be a lost investment in the stock market, real estate, business, or a personal loan.
You’re allowed to feel bummed about a lost investment. But what’s more important is how you recover. And for most people, recovery is all about learning from mistakes. To do better next time, you can try to understand what went wrong and consider making a plan to avoid similar mistakes in the future.
Try Not to Think Negatively
First, this bad investment or decision does not define you or your investment prowess. Even the best investors lose money from time to time.
While you may feel despondent after a lost investment, remember, there are more opportunities out there. Give yourself another chance.
What Went Wrong?
How much of this bad investment was due to your own miscalculations, and how much was due to factors out of your control? You could educate yourself on what went wrong to help make sure that you don’t make the same mistake again.
Investing is inherently risky, and it is in your best interest to do extensive research into your investments and diversified holdings.
Knowing When to Hold
Some asset classes, such as stocks, can experience volatile price swings. This should be expected of any individual stock, and the stock market as a whole. When looking at the performance of one stock or portfolio of stocks, it’s a good idea to compare it to the overall stock market. (This applies to any asset class, but it might be slightly harder to do with some investment types, such as private businesses.)
From time to time, the stock market experiences a particularly nasty downward swing, taking all stocks with it. You may remember this happening in 2008 . This doesn’t mean that the stock or that the stock market is necessarily broken, but that prices might be taking a temporary dip due to panic selling by investors or uncertainty regarding the future. If this is the case, you might want to hold on and wait for overall market conditions to improve.
Knowing When to Sell
On the other hand, being a good investor means knowing when to sell and walk away. In the investing world, this is called “cutting your losses.” This may sound easy enough but can actually be quite difficult due to the attachment we have with the investments we’ve already chosen.
If the investment is at a loss but the value of the investment remains in the positive, you are likely trying to determine whether you should sell and recover the available funds or to leave it as-is.
You may find it helpful to separate the investment itself from the dollar figure that remains invested after a loss. Then, you could decide whether it’s best to proceed with that dollar figure remaining in the current investment or do something totally different with that money.
It may help to think of the lost money as “sunk costs.”
The term “sunk costs” is used in business to describe costs that have already been incurred and cannot be recovered. In business, sunk costs are purposefully excluded from decision-making because they have no bearing on what happens in the future. You may find it helpful to apply this concept to your investment loss. This way, you can potentially avoid falling victim to the “sunk cost bias.”
Sunk cost bias happens when investors are attached to the idea of their investment and continue to put money toward it, even though this may increase the amount lost on the investment.
Let’s look at an example. Say that an investor spent $100,000 on an investment property that they deem is no longer a good investment. Still, it’s hard for the investor to simply walk away, and they may feel inclined to put more money toward the property because they’ve already invested in it. But this might not be the best course of action, and this thinking could make a bad investment worse.
Should that $100,000 be thought of as a “sunk cost”? If so, future investments should be considered independent of the initial investments. To do this, consider any future investments’ opportunity costs.
Opportunity costs refers to the economic opportunity that is missed out on because a specific action was chosen. When you spend money on an investment, the obvious transaction is that you gain an investment. But economists also like to point out that you lose out on the investments that you didn’t choose.
When you’re weighing what to do about an investment moving forward, it may help to consider opportunity costs of other options on the table. If you make one decision, what might you miss out on? Does knowing what you could miss out on alter your opinion about whether to stay or change course?
Selling out of an investment at a loss can hurt. One silver lining is that there could be a tax benefit to doing so. It’s not generally a good idea to make an investing decision based on the tax ramifications alone, but it may be something to include in your consideration of what to do with an investment.
When an investment is sold at a loss, it can sometimes be used to offset capital gains earned on another investment. There is a limit to the amount you can offset and what constitutes a capital loss, so be sure to check with a certified tax professional before making any decisions about your investments.
If your investment loss feels particularly painful, you might have invested too much in one investment type or concentrated area. For example, if you put all your money in just one stock. Putting all your eggs in one basket is a risky investment strategy.
Depending on your appetite for risk, you may want to avoid this strategy. Instead, most investors choose to diversify, spreading the risk among many investments.
For example, this could mean investing in some combination of stocks, bonds, real estate, a personal business, and other asset classes. This way, if one investment fails to perform, it will only make up a small percentage of overall assets and therefore won’t have nearly as much impact on a portfolio.
If you’re looking to build an investment portfolio and want some help, you could consider using an automated investing service like the one offered by SoFi Invest. Not only can this service help guide you into an appropriate portfolio considering your goals and risk tolerance, it can also do so with a diversified strategy.
SoFi automated investing uses exchange-traded funds (ETFs), which are a type of diversified investment company with low expense ratios. And there is no additional cost to the investor for using SoFi’s automated investment services.
If you’d prefer to pick your own investments and build your own strategy, SoFi’s active investing platform offers access to stocks and ETFs with zero trading commissions.
No matter how or where you choose to invest during the next go-round, recovering from a bad investment means learning from your mistakes and trying again.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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