[Editor’s Note: This article provides general, educational information on investor resilience and dealing with occasional sharemarket losses. Every investor is different, so seek advice from a licensed financial adviser or do further research of your own before acting on themes in this article.] 

The investment saying ‘time in the market is more important than timing the market’ is a beauty. It reinforces the power of long-term investing in shares.

Of course, long-term investing does not guarantee success. But more time in the market means more exposure to an asset class (Australian and global equities) that historically outperforms other major asset classes over time [1].

Time in the market requires resilience. That is, the fortitude to invest through occasional periods of stomach-churning volatility and portfolio losses. 

Resilience is built on principles of sound investing, such as portfolio diversification, patience, conviction and a long-term focus. Investing resilience usually comes with experience and a few hard knocks along the way.

Resilience also depends on avoiding investment traps. Holding too few stocks, allocating too much capital to a stock position, overloading on debt to buy stocks, basing decisions on “hot tips”, and speculating can kill resilience. These traps usually mean less time in the market for an investor.

There’s also a personal side to investor resilience. How one views market volatility, deals with market noise and copes with occasional losses has a big say in how much time you spend in the market. It’s easy to give up after a few losses.

ASX Investor Update asked four professional investors for their view on resilience and investment losses. How do they learn from their mistakes and become stronger, more resilient investors over time?

The experts were Sebastian Evans of NAOS Asset Management; Will Riggall of Clime Investment Management; Hugh Dive of Atlas Funds Management; and Nathan Bell of Intelligent Investor. 

We synthesised their views into 10 key insights:

1. Know what a loss is

For many retail investors, losses are clearcut. You lose money when selling a share below its purchase price. But consider an investor who worries about a 10% fall in their portfolio in a year. Compared to the Australian sharemarket which fell 15% that year [2], the investor has outperformed the market, even though the absolute loss still hurts. In relative terms, they have won rather than lost.

When asked about losses, NAOS’ Sebastian Evans discusses missed opportunities - the stocks he considered buying but thought were too expensive, only to watch them increase many times in value. “When we look back on losses, it’s often about the stocks we didn’t buy because we underestimated how much that a quality, simple business can grow over time.” 

Intelligent Investor’s Nathan Bell says “mistakes of omission” are the true portfolio killers. “The great stocks you don’t buy that go up 10 or 20 times outweigh the many poor decisions.”

The key is to measure your portfolio performance and compare it to an appropriate index, such as the S&P/ASX 200 Index for Australian shares. That way, you have more context to understand investment losses.

2. Some losses are inevitable

Clime’s Will Riggall makes a telling point: “A fund manager who consistently gets 60% of their ideas right each year will have top-quartile performance. Put another way, even the best managers get many ideas wrong.” Atlas’ Hugh Dive says if 60% of stocks in your portfolio perform as expected, “you’re having a great year”.

Having realistic expectations about share investing helps build resilience. Every professional investor has at least a few “howlers” (stock ideas that crash) during their career. Sometimes, they research an idea from head to toe and still get it wrong. Having some losses during your “time in the market” is part of investing. Minimising and recovering from those losses is what matters.

Hugh Dive says every portfolio should have a few losers in it. “If every stock in there is a winner, it’s probably time to sell the portfolio. You need some stocks in there that are currently out-of-favour, undervalued and can recover.”

3. Know your biases

Picture this: an investor buys a stock for $2, then watches it halve over the next few months after a profit downgrade. The investor resists selling, believing the stock will recover to $2. Their view is anchored to the past. Another investor refuses to sell because they have loss aversion. They avoid facts about the stock that contradict their opinion and seek facts that confirm it. 

Will Riggall says too many investors base their investment strategy on hope after a stock falls. “They change their view on the stock and hope that it will recover, even though hope is not an investment strategy. The key is to understand your investing biases when a stock disappoints and know how to manage them.”

4. Lose small, win big

An investor who has six winners and four losers in their portfolio in a year can still deliver attractive returns if the winners win more, and the losers lose less. In market parlance, this means “letting your winners run and cutting your losses early”. The trouble is, market volatility can leave some investors frozen with fear. When markets move quickly, their investing strategy is “hold and hope”.

Holding stocks through a period of losses (rather than crystallising losses by selling them) might be the right approach. So, too, could buying more of that stock if its valuation is more attractive after price falls. Another strategy might be to sell the stock early and minimise losses if something unexpected changes. 

“The key is recognising when you’ve made a mistake on a stock and moving fast to cut it from your portfolio,” says Hugh Dive. “For me, investing is fundamentally about limiting losses and avoiding capital destruction. If you do that, you have more capital to allocate to good ideas and let those profits run.”

NAOS’s Sebastian Evans says investors often sell their winners too early, keeping losers in their portfolio in the hope that they will recover. “The result is a deteriorating portfolio performance because you’re holding stocks that others don’t want.”

5. Do a pre-mortem 

Some investors rarely consider what can go wrong with a stock upon buying it - only what can go right. Intelligent Investor’s Nathan Bell always does a “pre-mortem” before buying. “That way, you’ve considered all the risks and probabilities upfront, so they’re less of a surprise should they occur,” he says. 

Doing a pre-mortem upfront can help investors imagine what could go wrong and how they would react. For example, an investor who buys a construction stock might decide the big risk could be a surprise earnings downgrade that is followed by another downgrade given that the business has high fixed costs. During the pre-mortem process, the investor knows how to react if that downgrade occurs.

6. Know why a stock falls 

Many investors view stocks in black-and-white terms. When the stock falls, they got it wrong. When it rises, they got it right. But as Clime’s Will Riggall notes, you can be right and wrong on a stock at the same time. “A stock might rally for reasons completely different to what you expected, which means your investment thesis was wrong. The same can be true when stocks fall.”

The key is understanding why the stock fell and comparing to why you bought it in the first place. For example, an investor buys a retail stock because they think it will grow by opening more stores. The retailer does just that, but its price falls 20% during a market sell-off. In this instance, the investor decides the loss is due to market volatility rather than changed company fundamentals, so buys more of the stock at a lower price. 

Some investment losses can be due to market volatility, changing cyclical or structural industry conditions, deteriorating company fundamentals, large investors exiting the stock, or just plain bad luck. The loss might be more tolerable if you can pinpoint its source.

7. Embrace volatility

Nobody likes watching the sharemarket tumble and their portfolio slump. Some retail investors panic and sell. Many retreat to the sidelines. Others take advantage of volatility to buy stocks at lower prices. They see the turbulence as akin to buying bargains in a department-store sale.

The key is understanding volatility and not confusing it with risk. Volatility denotes the size of changes in asset prices and is a measure of uncertainty. Risk is the chance of an investment’s return differing from an expected outcome. Volatility creates valuation anomalies when prices fall or rise too far due to sentiment.

Naos’ Sebastian Evans says some investors make bad decisions during market volatility. “They get extremely nervous and worry about their losses. But often during these times, you get to buy good companies at lower prices. If you invest for the long term, as we do, the volatility can create opportunity.”

8. Commit to learning from mistakes 

Atlas’ Hugh Dive says he learns far more from stock losers than the winners. “During their career, every fund manager gets some very hard lessons drummed into them, thanks to losing stocks. These can be really valuable insights that help you in the future, even though they are painful at the time.” Clime’s Will Riggall says learning from mistakes is the key to becoming a better investor. “You need to commit to learn from losses and embed those learnings into your process.”

This is not easy. Some investors want to forget about stocks that burn them. Others cannot rationally learn from the mistake because their judgment is clouded. They can’t extract value from losing ideas – the lifelong lessons that make them more resilient investors.

9. Put emotion aside

Intelligent Investor’s Nathan Bell says the worst mistake is getting emotional about losses. “Research shows we feel losses twice as much as our wins, so it’s easy to lose confidence after a mistake and miss out on the next great opportunity.” Clime’s Will Riggall says the best way to “dust yourself off” after a loss is by looking at new opportunities. “Our team thinks about every dollar as a unit of capital we can allocate to any stock at any time. When you think about investing in terms of capital allocation, it frees up your thinking and reduces stress.”

Even great investors sometimes struggle to park their emotions when stock ideas turn sour. It’s natural to be elated when stocks rally and disappointed when they fall. The key is understanding your emotions and having portfolio processes, such as rules to allocate money to ideas (position sizing) or pre-determined points to minimise losses (stop-loss levels), that reduce the effect of emotions. 

10. Seek help if gets too bad

Investment maxims about “time in the market” and “cutting losses early” sound great on paper. But all the investment information in the world might not help someone who loses a significant amount of capital they cannot afford. For some people, intense market volatility and heavy stock losses can create ongoing financial stress that damages their physical and/or mental health.

If you are struggling with stress from investment losses, seek help from medical professionals or through national mental-health helplines and other support groups. The National Debt Helpline, for example, provides free and confidential financial counselling.

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[1] The 2023 Vanguard Index Chart report found US had the highest average return, followed by Australian shares, over FY1994 to FY2023, of all major asset classes.

[2] As measured by the S&P/ASX 200 Accumulation Index (which includes dividends)

DISCLAIMER

The information in this article should not be considered financial-product advice or investment advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 30 September 2023.