Investing can come with a variety of risks, but all you seem to see in the media are people who make millions in investments. Is this possible? Does anyone even LOSE money in stocks? You begin to doubt whether investments can actually go negative. Is this something to even worry about?
Unfortunately, investments can go negative – the only saving grace is that, if you’re only investing your own cash, you cannot lose more than you have invested. However, if you invest using leverage, you are investing MORE than you have in cash and may be in serious financial trouble if investments drop.
At this point you’re probably wondering – well what do you mean by ‘go negative’? what actually makes stocks go negative? and what’s all this talk of leverage?
What do we mean by ‘go negative’?
An investment goes negative when the share price dips below what you bought it for. Let’s say you bought stock ABC at £100, after one week the stock price fell to £90. In this case, your investment in ABC is in the red by 10% (or has lost 10% of it’s value). On the other hand, when the stock price increase, let’s say from £100 to £120, you’ve just gained yourself a cool 20%.
It is worth noting that in all these cases, the gains or losses are just on paper (also called ‘paper gains or losses’) – they’re only ever real when you sell your investment. This is something every investor should ask him/herself when selling off stock when it’s negative – ‘is there any chance that if I hold this longer, it will go back up into a positive?’
As you invest, you need to understand that the value of your investments can fall as much as they can rise. I’ve written a great article called ‘Investing: Which Investments Don’t Lose You Money?‘ which talks you through the best way to stop them from falling – however it’s never a guarantee!
What makes an investment go negative?
Warren Buffett (you know, the guy who’s super-rich from investing), has two rules for investing. Rule one, “Don’t lose money”, Rule Two, “Don’t forget rule one.” I think these two rules are important to help you know that you can lose money while investing. Hence, you need to protect yourself against it and try to minimise the odds of your investments going negative.
So what can make investments go negative? Different factors could be responsible for this. Whether it’s investments in stocks, bonds, property, or gilts – there are many things that affect their performance and therefore their price.
The biggest factor impacting an investment’s price movement is supply and demand! When there is more demand than supply, the price will rise. When we talk about demand here, we’re talking about the number of investors who are willing to buy the investment.
At the same time, if more investors want to sell this investment than there are buyers and there are a lot of shares available on the open market, the price will fall. This indicates that supply has exceeded demand so the price goes down.
‘So what are the factors that make investors want to buy or sell an invest?’ I hear you ask… well let me explain.
These key factors include:
- The value of the investment;
- Current interest rates;
- Expected economic growth/performance; and
- Investor confidence/sentiment.
The value of the investment
This one is pretty simple – if the share prices is looking super low (due to external factors like investor sentiment or government policies – anything that won’t impact the recovery of the share price), then you’d be a fool not to buy in right?
It should be noted that a low value share and an undervalued share are two different things and pose different risks. I’ve written an article called ‘Buying Stock When It’s Really Low – Should You Do It?’ which explains what you need to look for when assessing if a stock is undervalued so I’d recommend giving that a read if you’re not sure.
Another great resource to utilise if you want to learn more about undervalued stocks is a book called ‘The Intelligent Investor’ – this was written by Benjamin Graham (Warren Buffet’s investment mentor). It’s on my recommended books list if you wanted to check it out.
What can investors do to protect their investments?
As we’ve already discussed, there is a real risk that investments can go negative. If investments can go negative, it means that investors must take steps to avoid and prevent any damage occurring to their portfolio. So here are some ways an investor can protect their investment.
Diversify your investments
At this point, it is worth mentioning that all investments are not exposed to the same risks. However, the investor’s number one defense is diversification. Diversification essentially means having ‘multiple fingers in multiple pies’. An investor can (and probably should) invest in stocks, government bonds, property, or gilts to avoid any one investment crumbling the portfolio you’ve worked so hard to build.
Due Diligence
If you want to stick to Warren Buffett’s rule of not losing money, then doing your own research/due diligence is a complete must. This reduces the risk of investing in ‘a bad apple’ and gives you comfort of knowing why the share price has moved in the ways it has in the build up to the present.
Without carrying out due diligence, you may pick a stock that is on the verge of collapse. But as my Mum always said ‘Fail to prepare = prepare to fail’ – cheers mum. I’ve written a pretty good article called ‘Want to Manage Your Own Investments: Here’s How‘ which explains my personal research methods in a bit more depth.
Take Emotions out of Investing
My final tip to safeguarding against your investments going negative is to ensure you always take the emotions out of investing. You’ve come this far – you’ve identified your potential stock, you’ve done extensive research and are happy that it will be a solid investment to hold.
All of this will be for nothing if you see a little bit of short-term volatility and decide to abandon ship! By selling when you see the negative go red will lock in those losses and you’ve officially lost money.
Fear and greed are seen as the emotions that affect investors most. Warren Buffett’s advice on fear and greed is, “Be fearful when others are greedy, and greedy when others are fearful.”
Summary
So let’s have a little recap over what we’ve spoken about.
All investments come with some level of risk and all have the potential to go negative, however, you will only ever take a loss ‘officially’ if you sell whilst it’s negative. It’s super important to do your research before you invest and don’t be a sucker who panic sells investments when everyone else does – understand why people are panicking, determine if the reason will impact the recovery in the longer term and maybe pick up a bargain or two.