Investment is no child’s play, it’s a complex affair! Often when it comes to investing we tend to look up to people who have some knowledge of it or have done it before. The reason that we do this is because we want an assurance that we would not lose our money no matter what it is. What we misunderstand is that not every loss would really mean loss of our money.
The moment you see losing your money, does it mean that you need to run with your money the moment you get a whiff of loss? Not really? You must be thinking that what kind of an advisor I am that I am asking you not to get worried as soon as you see a loss. Well, in the world of investments there are two types of losses that any investor can witness. Hence the decision to run away with your money would depend on what kind of loss have you incurred.
Loss is not what matters, but what kind of loss!
There are two types of loss that investors require to deal with. One is called Quotational Loss and the other one is known as Permanent Capital Loss. Let’s examine each, one by one:
Quotational Loss
Quotational Loss is merely a short-term fall in the stock price with the underlying value broadly intact. You need not worry about your investment in this case for the simple reason that quotational loss doesn’t affect your prospects in a serious way or in the longer run. The reason is that even if there’s quotational loss, your capital investment will remain safe.
Quotational loss may arise due to any of the following reasons-:
1. Unfavourable market conditions
2. High valuations
3. Unforeseen incidents including accidents in the factory, delay in rolling out a new product or lower than expected profits for a quarter or two
If you hold a fund in the time of quotational loss, you don’t need to panic. On the other hand, it’s an amazing time to increase your investments or if you don’t have one; start new investments as the prices are low. ‘Be patient and just hang in there is’ is the mantra you need to follow as things will get back to normal soon.
Permanent Capital Loss
Quite unlike quotational loss, permanent capital loss is a serious problem. In permanent capital loss also, the stock prices see a dip but here the dip is because the value of the underlying business is seriously eroded.
Let’s take a look at what are the factors that trigger permanent capital loss. Broadly these factors can be categorised into two, namely industry-specific and company-specific. The industry specific reasons can as follows:
1) Emergence of a new substitute
2) Changes in government regulations such as price regulation, import duty, significant tax rate revisions etc.
3) Disruptive technology
The company-specific factors that lead to permanent capital loss vary from
1. No succession or weak succession plan
2. Fraud, mismanagement or
3. Lack of a clear growth strategy etc.
Thus if you see a dip in your investments due to any of the above listed reasons, its time to run away with your money before your money clearly wipes out.
The Conclusion
Time is now to wind up. But before that, let’s take a look at the key learnings. What should be your action plan in the wake of a price fall?
First, analyse the situation properly and find out what is the reason behind the price fall. Secondly, if you can see signs of permanent capital loss, take measures to reduce your loss by opting out.
If it’s just a quotational loss, stay in the game and come out with a permanent capital gain.
