Don't dig a bigger hole!

Today, in my chatbox, a chatter has the courage to share with us his investing losses. He considers himself more an investor than a trader - apparently, he still hold stocks bought a decade ago. At the height of the bull run, his account showed a total net profit, but to date, he estimates that his account is losing approximately 60% with some stocks losing 90%.

His experience is probably not unique. The recent "crash" has taken away a lot of the retirees savings, especially in the US. Investors who invested in Bear Stearns and Lehman have lost their retirement savings, and even those who invested wholly in AIG - the company that until recently had AAA rating and couldn't be more secure - has lost nearly their entire retirement savings. For these retirees who had looked forward to a wealthy retirement, their retirement dreams have been destroyed totally. It is a tragedy for these people, as it would mean that their lives - going forward from here - would need to change in a drastic manner, including the need to continue working past retirement age to find continued income, the need to cut down on monthly spending, forgo the little luxuries left and have monies to spend only on the necessities. Sadly, a forced and complete change in lifestyle.

The reason I point this out is because if you think you have it bad, there are thousands and millions out there who have it worse. Psychologically, I can only imagine that the worst cases must be devastating. The chatter shared with us his loss of confidence, which I suspect is only the tip of the iceberg. I'm sure many have seen similar situations with friends, ex-colleagues, families who temporarily lost a job and the means to support their family. There is a psychological impact that is not easy to shake off, because the effects is felt on a daily basis.

However, there is hope. I do know that people who lost jobs gained hope when they took action, and was given a job interview! You see a tremendous change there. Similarly, I believe that those who lost money in the stock market can also feel a deep psychological change if they start to have wins again in their trades. The account might not go back to zero immediately, but the hope is there after a string of wins.

And I believe that's basically the objective for someone who has lost money from this round. The first thing I believe is to commit to yourself that you will stop digging a bigger hole! The last thing you want to do is to dig an even bigger hole that makes it "more impossible" for you to get out of.

If you find yourself in this situation (having a net negative account despite years of investing and feeling depressed), I think there are a few critical steps that you need to take to get out of this situation and this feeling of depression.

1. Know your situation first. A jobless person knows exactly the problem, because he doesn't have a job and doesn't have a regular income. Likewise, if you are investing and have a job, the first thing is to make sure that your job is secure, because a regular income provide some peace of mind. The last thing you want to do is to lose that job income as well, then, psychologically, it becomes even more damaging. (related to this is to also be opportunistics to ways to improve yourself financially in a responsible manner)

2. Know the exact problem. As hard as it seems, I suspect most people who had losses will find it difficult to know exactly how much they've lost. I know, because during 1998, I had similar experience, and I simply didn't want to look at stocks for months. But I believe that the last thing you want to do is to not know your problem. So, my advice would be to take a deep breath, total up the market value of your stocks, compare that with the purchase price, and work out the exact $ loss and exact % loss. For example:

- If you had allocated $500,000 to invest in stocks (all numbers here are purely hypothetical).
- Cash balance is $25
- Market value of stocks is $189,321
- Then, current portfolio is $25 + $189,321 = $189,346.
- Your loss = 500,000 - 189,346 = $310,654,or 62.1% loss.

You know this exact number. Your goal is to not make this worse if you can (see below).

3. Self-acceptance. As hard as this may sound, you need to accept that your paper loss of $310,654 or 62.1% loss is a real loss. This number may be a different number tomorrow, but the fact that you are depressed at this juncture is probably enough to indicate that you have been holding on to the loss for some time, and longer than you expect. You should do a thorough analysis of the stocks you own.

If you are honest, the reason you are in this predicament is simply because you didn't invest or trade with a stop loss. Yes, Warren Buffett said that you should be willing to see an unrealized loss of up to 50%, but he was silent on what happens if it becomes 60% or 70%. More likely, you are in this problem because you paid too much for a business that is probably only average or below average quality. Since your stocks aren't exactly Buffett-like stocks, so, you shouldn't blindly copy Buffett's 50% unrealized loss rule. You should have taken action earlier and quicker.

So, bottom line is odds are high, that you are probably holding to an average or poor quality stocks. If you don't know how to identify this, then, get many 2nd opinions because this is critical. Basically, you need to be prepared for your worst case scenario if the stock price falls further.

4. Commit and resolve to yourself that you don't want the problem to get significantly worse than where you already are.

The root cause of the problem is most likely owning a set of average quality stocks. The problem with this is that the downside is not necessarily limited. If the stock market gets worse than the recent low, your stocks may create new lows and new losses. This is an uncertainty that is not easy to evaluate for the untrained investor/trader.

But what is within your control is your maximum loss. At this point, it is 62.1%. What is your tolerance level? Can you "tahan" 65% loss? $325k loss? Or 70% loss? $350k loss? Try visualizing this as detailed as you can to see if you can try to pre-determine this.

5. Know the maths. Realize that a 50% portfolio loss requires 100% return to break even. So:
- 60% loss requires 150% return to break even.
- 65% loss requires 186% return to break even.
- 70% loss requires 233% return to break even.

Know that there is huge difference between getting 150% future returns vs 233% future returns. In short, your strategy should be to minimize your loss, preserve your capital, so that you have bigger bullets to fight another day.

6. At the time of writing (lunch time, Tuesday, Oct 14), there is a general market rebound after the crash, but I don't know how long this will last exactly. If in doubt, consider the possibility of selling some of the stocks during strength, even if you sell only 10% or 20% or a larger number. Every sale at strength helps provide some comfort in that the maximum loss gets smaller and smaller, but it also reduce the probability of breaking even again in the immediate term.

7. Selling is an art, and I doubt I can cover this nor do I consider my sell method foolproof. But the general idea - if you are an avid stock price watcher - is to sell only when you think a downtrend is imminent and that you are confident to buy back at a lower price. But implementing this is much harder than it sounds.

8. During these times, you will be tempted with "quick rich" schemes. In fact, someone in your situation is probably ripe for the unscrupulous to promise you a quick way to get back your money, and steal all of it away! Don't! Don't be tempted with "get rich quick schemes"!

The truth is - in my experiene - there isn't any reliable quick methods to get it back. The lucky ones are very few. Most who tried loses it all.

The general rule of thumb is that since stock market rises slower than it takes to crash, if it takes you 1 year to get into this hole, give yourself at least 2 to 3 times longer to get it back. In other words, the only way to get it back is the slow and steady way.

I do realize that some recommends futures or options to try to get it back. I don't! If you can't make money using stocks, chances are good that you will blow it all away using leverage products.

Remember: Whatever you do, don't dig a bigger hole than the hole you are already in. And never forget the maths! And be patient. If it takes you 1 year to get into this mess, give yourself 3 years to get it back. Sadly, it will take this long, but the critical thing is to be patient. Don't average down, don't buy more, until you are sure the odds of the price going up is higher. And don't be greedy or afraid that the price will run away from you. That will only cloud your thinking.

Good luck.