How to Avoid Losing Money While Investing

By: Sandy Stuart, Investment Advisor
How to avoid losing money while investing in mutual funds. That's one ambitious claim. Sounds like one of those "too good-to-be-true" investment claims you can tune into on TV in the wee hours of the morning when the listing is "paid programming". You know that type of program. First they try to scare the pants off you and then sell you an investment they are touting as a cure-all.

When do you lose money while investing? Only AFTER YOU SELL an investment for less than what you paid for it. So when clients open their monthly Fidelity brokerage statement and see their investments have dropped in value, they have not necessarily lost anything. And they will not lose unless an investment is sold at a loss.

I am backed on this issue by no less than your friendly Internal Revenue Service! They will only allow losses to be taken after an investment has been sold for less than it was purchased. All drops in investment value are considered "unrealized losses" until sold. Some call them "paper losses".

This concept may seem simplistic. But if you can internalize it, you will be better able to sleep well at night.

So, to avoid losing money on your investments, the key is not having to sell an investment when it is down in value. How can you do that if you need some cash from your investments? The answer is one of those investment principles that just won't go away! DIVERSIFICATION is the name of the game. You might be thinking that all mutual funds are diversified, and you are right. But you need to have another level of diversification. Specifically, you need to have some bond funds, as well as stock funds, in order to take advantage of the tendency of bond funds to do well when your stock funds are hurting.

There have been fairly rare times when both stock and bond funds dropped in value. That condition didn't last very long (maybe a month or two). Even during such periods, bond funds did not drop in value by much compared to stock funds. So even then the losses were minimal, especially if you had positions in various types of bond funds. Our clients typically will have short duration, mid-term, long-term, inflation-protected and international bond funds. It is even rarer that all types of bond funds drop in value at the same time.

In summary, if you have say, several years' worth of living expenses invested in various types of bond funds, you should very rarely have to sell stock funds at a loss. Just sell some of your bond fund holdings instead.

Ain't it great to be well diversified!