Psychologists have written extensively about defense mechanisms people use to eradicate things that are unpleasant or detrimental from their perceived reality. A disastrous investment is a perfect example of something anyone would like to reverse or undo.
The loss of a large amount of money can have a traumatic effect on individuals, particularly if that loss impacts important life milestones, such as retirement, paying for a child's education, or the purchase of a home. Many individuals may feel that there is no coming back from the financial loss and therefore take actions that exacerbate the situation.
Though unfortunately the clock cannot be turned back, it is better to manage the process psychologically than to try and make up the losses through risky investments or other drastic measures. Studies have shown that there are positive ways to deal with such losses as well as identifying harmful methods and how to avoid them.
- Human beings naturally try to avoid losses, and when losses do happen it can cause psychological and emotional stress.
- Losses in the markets are inevitable, and so dealing with losses is key to picking yourself up and recovering from it unscathed.
- Here we go over some negative and then positive ways to deal with financial loss.
Dysfunctional Coping Strategies
When faced with losses, many people employ dysfunctional coping strategies. These include:
- Suppression: Trying to suppress the negative feelings associated with a loss can be difficult and come back to haunt you. Financial problems and loss-induced distress can easily turn into marital or career-related problems or stress. You could end up taking out your frustrations on your family, colleagues, or friends.
- Projection: It is not uncommon for those facing a big loss to try to blame it on someone or something else rather than taking responsibility for their own poor decisions or excessive risk-taking.
- Denial and self-delusion: These dysfunctional coping methods lead people to cling to failed investments in the vain hope that "they will go up again." If you bought a dud, it is almost always best to get rid of it and put whatever money is left into something safer and sounder. In short, cut your losses and move on.
Sound Coping Strategies
Assuming you have no legitimate claim against the seller for your losses, or cannot afford to go down the route of litigation, it is necessary to come to terms with the situation. One meaningful way of coping is simply to learn from your errors and try to recoup the losses over time by investing well and prudently in the future. This is not a quick fix or "sure thing," but it certainly makes sense to try.
If you took excessive risks, trusted the wrong people, or were just plain unlucky, you can be more careful and diversify your portfolio more in the future. Even if it takes years, you may well find that you do get some, or all, of it back, and it's comforting to think this might happen. Diversifying your portfolio should always be an early step in investing that will ensure a balanced portfolio that will avoid drastic losses.
Keep in mind that some investments simply do go wrong. There are incompetent, unethical, and dishonest people in the industry, and anyone can be a victim. That is life, and what doesn't kill you can make you stronger.
Learn from Mistakes
Rationalization is useful, but only if it is realistic. It is important to understand what you and others did and why. For instance, were you tempted by the lure of big money, or were you the victim of false promises or even fraud?
Getting to the bottom of what really happened in the past is the best way to move on to a better future. But when rationalization is really self-delusion and entails blaming others for your own mistakes, or not facing reality, the process becomes a negative one. Trying to understand why you made an investment decision can help you avoid poor investment decisions in the future.
Seek Professional Help
In the event of particularly severe losses, and even possibly with those that do not threaten one's financial survival, there are cases in which people suffer from depression or even despair. As such, they may resort to those negative coping strategies discussed above, or worse. In such instances, professional help may be required.
Finally, in terms of investing your money well in the future, it may be worth employing the help of an independent financial advisor with a good track record.
Frequently Asked Questions
What are some good ways to deal with trading losses?
Experiencing losses in the markets can be painful, but they are also almost always inevitable. Assess what went wrong carefully and objectively. If the cause was out of your hands, there is nothing that can be done. If you identify mistakes or missteps, take responsibility and learn from them. If you can't figure out what went wrong, either due to your own fault or something exogenous, then maybe take a break from trading for a little bit.
Is doubling down on a loss to break even a smart strategy?
No, probably not. But this is exactly what loss aversion describes—taking on excessive risk in order to make back a paper loss instead of biting the bullet and realizing it in order to move on. In trading this is known as the disposition effect, which causes people to hang on too long to losing trades.
Why do many traders fail?
Traders often fail when they let emotions like fear, greed, overconfidence, and herding behavior take over. This can lead to overtrading, trend-chasing, and scrambling to make up losses. Having an objective and unbiased strategy, which can be revised over time, and sticking with it is key.
The Bottom Line
Investing is a risky endeavor as there is so much uncertainty around it and moving variables. Losses are common and a part of the risk. While changing the past is impossible, you can control how you react to it. Choosing sound coping strategies will help you move on faster and may even enable you to recoup financial losses.