On Capital Gains & Losses Part IV

Dealing With Anger & Stock Losses.

{I am linking Parts I-III here. 1. http://lumencapital.blogspot.com/2009/06/on-capital-gains-losses-part-i.html 2. http://lumencapital.blogspot.com/2009/06/on-capital-gains-losses-part-ii.html 3. }

I'm very aware that individual investors are in general dissatisfied with stocks and likely the people who invest for them. I certainly understand why. Stocks have basically spent 13 years going nowhere and that sort of performance can take the wind out of the most ardent investor's sails. Perhaps you would expect me now to try and make a compelling case for equities and why you should remain or become invested.

I'll do no such thing. I'm assuming that if you are reading this then you already have decided to be involved with some portion of your money. I will simply point out what I said last week that I think because of their historical return potential that investors need some exposure to equities as a class but not necessarily to individual stocks. I'll leave it at that. I will however point out what I have stressed in other posts If you currently own stocks then for reasons we've already discussed you are likely already dealing with losses. Many investors aren't happy about that fact so today we'll discuss how investors are feeling and what to do about it.

First its OK to be angry right now. Much has come over the transom in the past year and there is plenty of blame to go around. . But anger without understanding what has happened and anger without having a plan going forward will not begin to dig any of us out of these circumstances.

Investors need to understand that stocks have and always will be volatile investments. Today's markets where information is instantly transmitted has brought about much higher levels of volatility. Most of us remember the 1994-2000 bull market where stocks did experience lower volatility at least to the downside and where stocks yearly posted double digit returns. History is likely to show that period as an anomaly, probably not to be repeated soon. That is not to say the market won't get better, but to expect us to revert to that sort of experience is I think a futile hope given our current economic problems.

Higher volatility brings a higher possibility of being on the wrong side of a trade at any given point at least in the short term. Investors often get angry at this when they buy a stock and find they are down 5-10% in a blink of an eye. Often that can be due to a lack of understanding about current market dynamics or a lack of tools to understand oversold or overbought markets. But often it is simply the market's internal noise. Investors need to understand that this is part of the natural order of things and develop tactics and strategies to deal with it.

Markets also crash more often than most investors think (Investment jargon for this is a rapid period of negative price adjustment!). I started in the business in 1987 right before my first crash. Besides then, stocks have experienced short term declines of 15% or more in 1990 (first Gulf War), 1998 (Long Term Capital Management), 2001 (World Trade Center), 2002 (run up to 2nd Gulf War), and last fall. I find it interesting that 4 of these events have occurred basically in this current poor period for stocks. It translates however in my 22 years to a rapid decline of 15% plus, once about every 3.5 years. Since 1998 that has been about once every 2.75 years. If we are going to invest in equities then we need to plan for this. That isn't to say we should be happy when it happens but we do need to expect that something will again come forward to cause stocks to violently correct and plan for it. There is probably no way to completely ever avoid such an event but investors can attempt to minimize its impact on their portfolios.

Also as we pointed out last week losses are part of the investment equation. Investors also often feel the pain of losses more keenly than the joy of gains. There is no holy grail that can keep losses from ever occurring even in the best of times! Investors have a right to be angry about what has happened. Yet anger without understanding the inevitable nature of certain losses or anger without developing future plans will not help your portfolio. There are ways to mitigate the impact of losses on portfolios just as there are certain ways to use them to your benefit in your long term investment planning. We'll begin looking at this next week.

{Next Week -Losses in the Investment Playbook }.