The stock market finished down over 20% in the first half of 2022, one of the worst on record. It’s no wonder investors are worried about the money they’ve lost. I get it—bear markets aren’t fun. They can be highly stressful and it’s okay to be concerned about your money.
But here’s the truth: you haven’t lost any money…yet.
Without coming across as apathetic, your “losses” right now are only on paper. The price of your stocks is simply the price someone else is willing to give you for them.
I can’t guarantee that the price of your stocks will never go down. They will—often. But prices going down is different than losing money. As long as you don’t sell your stocks, your losses will remain on paper. Once you sell, the loss is locked in.
How to not lose money in the stock market
So how do you make money in the stock market? Or better yet, how do you avoid losing money?
The good news is you don’t need a specialized degree, insider information, or a crystal ball. You simply need three things:
- A well-diversified portfolio of publicly-traded companies.
- The ability to withstand bear markets that happen every five years or so.
- Time in the market.
A well-diversified portfolio
When I’m talking about investing in stocks, I’m referring to a well-diversified portfolio. Either owning a bunch of individual stocks or more commonly, owning mutual funds or ETF’s. Why is this important? It’s much harder to own stocks of only a few companies. Not only can individual companies go bankrupt (and your stock goes to $0), but individual stocks display much greater volatility.
Look at the following three stocks which were favorites during the pandemic of 2020: Peloton, Zoom, and Netflix. All three benefitted from stay-at-home and work-at-home policies. While the S&P 500 “only” returned 18% in 2020, these stocks had calendar year returns of 434%, 395%, and 67%, respectively. At one point in October 2020, Zoom was up over 700% for the year!
Now these stocks have done an about-face. Peloton is 94% off its high, Zoom is down 80%, and Netflix has lost 74% of its value from its high, while the S&P 500 is down a mere 18%. Consequently, the S&P 500 has the best total return of this group over the past three years.
While none of these stocks have gone bankrupt, it’s hard for me to tell an owner of these stocks to stick it out. I don’t know if Peloton will regain all the wealth that you’ve seen disappear. There are unknowns unique to that company and its market.
So, the first step to not losing money is to diversify. Individual companies can and do, go to zero. Can the largest 500 companies in America all go bankrupt? Theoretically, yes. In reality? Probably not.
The behavior to withstand bear markets
Putting together a portfolio isn’t the hard part. The challenge is to stay the course when the value of your stocks is going lower.
In his book “Simple Wealth, Inevitable Wealth,” Nick Murray describes the US economy as “one of permanent advance punctuated cyclically by temporary decline.” In other words, the advance is permanent—the declines are only temporary. Does it hurt? Sure, but you can still be confident of higher future returns.
How often do poor returns materialize? A 10% correction occurs quite frequently—about every 16 months. A 20% drop (known as a “bear market”) occurs about every five years.
Say you are 30 years old and starting your investment journey. If you live to age 90, chances are you will live through 12 bear markets! If you are just starting retirement, you still might have five or so bear markets to live through. So, it’s a matter of when you will experience your next bear market.
If your portfolio sees a 20% drop every five years, that must have a real drag on your returns, right?
Wrong. Even with the temporary declines, the advance has been permanent. Having $10,000 invested in the S&P 500 in 1990 with dividends reinvested would be over $214,000 today. All those shaded areas represent recessions. As you can see, even with some bad years, your long-term returns have been phenomenal.
Time in the market
The last step to not losing money in the stock market is to let time pass. Time is the ultimate antidote to risk.
Over the short-term, returns are a crapshoot. As you can see in the chart, the more time passes, the higher probability you have of positive returns.
This has to do with why stocks go up in value. Remember, when you buy stocks, you are buying shares of ownership in companies. Companies generate earnings from the products or services they sell. Over time, good companies grow their earnings. Stock prices follow earnings; hence they go up over time.
Again, the advance of the US economy is permanent. It’s punctuated by temporary declines—we call these recessions. Recessions allow companies to do a sort of reset. They get leaner, more focused, and more efficient. They come out the other side stronger than before. After experiencing a drop in earnings for a short period of time, earnings begin to grow as the economy once again expands.
What’s going to happen to stocks this month? I don’t know. What will happen over the next 10 years? I’ll put my money on prices being higher than today. Why not? History tells me I have a 97% chance of being right.
Bringing it all together
Being in the middle of a bear market can be scary. Your portfolio is down, and it seems like silver linings are in short supply.
The good news is you haven’t lost money. Again, right now your losses are on paper. The value you see on your statement is simply the value someone else is willing to give you for YOUR stocks. You can choose to ignore that person’s offer and continue holding onto your ownership in those companies. Afterall, if you have the three qualities we discussed, what are you worried about?
