Move My Investments to Something Safer!
When the market goes down, many people, particularly inexperienced investors or those who do not really understand the stock market, just want out. They are afraid that even more of their wealth will disappear and they decide to head for the safety of a bank account, but often all this does is locks in a loss.
If your investment is losing money or not making as much money as you would like, you need to consider several questions:
- Why is my investment losing money? What would need to change in order for it to make money?
- What is the purpose of this investment?
- What are the other options?
Let's look at those questions with respect to some investments I've discussed on this blog.
When I started investing via Lending Club and Prosper, average returns near 8%, at least when the economy was good, appeared do-able, though I was aware that if there was an economic downturn, defaults would likely rise. I thought it was worth the risk, and at first it seemed like those would be good investments. Then I noticed the returns dropping, and reading various blogs and other information available online I realized I was not alone--many investors were having all their interest for a month eaten up by defaults. So, on to the analysis:
- Why is my investment losing money? My investment is losing money because Lending Club and Prosper's rates are too low for the risk the borrowers pose. When it became apparent that more people wanted to invest in their notes than wanted to borrow money, Lending Club and Prosper lowered their interest rates/loosened their standards to attract more borrowers. Since Lending Club and Prosper make their money servicing the loans rather than investing in them, it is to their advantage to write more loans. As an investor, I have no control over the underwriting of the loan and no expertise that would allow me to design a meaningful filter to check Lending Club or Prosper's underwriting.
- What is the purpose of this investment? I invested in these notes because I wanted income and wanted some liquidity. They are still providing limited liquidity--each day I have the choice to re-invest money paid to me, or to withdraw it. As an example, this week I will be withdrawing $155 from Lending Club and $131 from Prosper, and those are sums that have accrued this week. However, last year my interest only exceeded the amount lost to defaults by a small amount, so this investment is not providing the income expected.
- What are the other options? The traditional income investment is bonds and/or bond funds. They provide income and liquidity. Yes they can go up and down in price (and lately bond funds have been decreasing in value) but they have a longer history than peer-to-peer lending and there are professionals on both sides of the bond transactions, whereas with peer-to-peer lending the party with the knowledge to properly price those notes has more interest in the loans being made than in them being paid.
- Conclusion: I'm withdrawing money from Prosper and Lending Club. I'm not saying I'll never invest with them again, but the odds are against it. I think buying a diversified bond fund is safer and the income more predictable. While my overall return now is better than what most bond funds pay, the economy is good. If a downturn occurs, I expect defaults to rise and right now, my account can't take more bad news and remain profitable.
The Stock Market
All of my investment accounts are worth less than they were two months ago. I made lots of money in the stock market last year; am I going to lose it all this year? Who knows?
- Why is my investment losing money? The talk of tarrifs is what the professionals blame last week's problems on. Whatever the problem is, I have a lot of company. Most stocks and mutual funds were down about the same percent as I was.
- What is the purpose of this investment? The purpose of investing in the stock market is long term growth. Statistically speaking no other investment has outpaced inflation over the long term. However, historically speaking the stock market has had its ups and downs. The market may be down this month for whatever reason, but there is no reason to think that it won't eventually go up again. Since this is money meant for long-term growth, I can afford to wait.
- What are the alternatives? Bonds, bank accounts, real estate. Long-term all pay less than stocks.
- Conclusion: Selling stocks because of a market decline just locks in losses. Market declines are going to happen, but long term, the market, as a whole, is a winner. Market declines are good times to buy stock if you have extra cash sitting around.
My Shares in XYZ
If you own shares in XYZ (fictitious company) and they fall, then it is time to look at XYZ.
- Why is my investment losing money? Hmm...beats me, but the market has a whole as dropped about the same as XYZ. Well, it is likely that when the rest of the market recovers, so will XYZ. If you want more XYZ this could be a good time to buy.
XYZ just got sued in a big case. XYZ just changed CEOs--the last one went to jail. No one is buying XYZs products and they've laid off half their workforce. The price of XYZ has decreased because the value of the company has decreased. If you believe the company's prospects are good despite this news, hang on for a bumpy ride. If you have no reason to believe the market is wrong, then get out while you still have some value.
- What are the alternatives? There is a whole stock market full of alternatives
- Conclusion: If an individual stock falls, find out why. Use the answer to that question to help you decide whether your money would best be deployed elsewhere.