There are inevitably times when your portfolio will be worth less than a previous high. In my experience there are certain mistakes that can make those losses more frequent and more severe. Frequently, investors good at losing money chase past performance i.e. they invest in something because it has increased in value. Last year’s performance is last year’s performance and is money someone else has made. By investing now, you are not going to benefit from that. When assessing the valuation of an investment, the journey its valuation has taken to get where it is, is one of the least important factors and tells us the least about whether the current value is a fair value.
It is far easier to lose money with a narrow portfolio than a diverse one. Inevitably investments sometime fail. The complete failure of an investment, e.g. a company “going bust”, means you’ve lost that money forever. If you have a diverse portfolio, i.e. other investments and they increase in value, then they can compensate for that loss. Building a truly diverse portfolio, that spreads your investments between different asset classes and regions makes suffering a total and permanent loss far more difficult.
Misunderstanding the risk and reward of an investment can be a further way of minimising returns while increasing the chance of a loss. Depending on how information is presented we can be far too focussed on one side of the equation. Are you happy with an investment that could fall to zero but at most can make you 7% per year? Such investments are how lots of investors lost money with “mini-bonds” in 2019. Whilst the asymmetry of the risk-reward equation was very much against them, marketing material focussed on the regular income not the risk to capital. It was a similar story but at an institutional level that created the subprime mortgage crisis. Sometimes investors know a risk is there but ignore it altogether because it is inconvenient to consider it. The most frequent example of this is choosing to ignore the inflation risk when putting money away for the long term. Losing money can be very easy if you fall into these traps and making money becomes much more likely if you don’t.
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By Richard Cohen FPFS ACII MCSI Chartered Financial Planner