To sell or not to sell? That is the question in a falling stock market.
When markets are up, investors typically feel confident in their decision to invest. But when markets turn down — or, as with the recent coronavirus pandemic, way down — many get nervous and rethink their decision, even if it was part of a sound strategy. Problem is, that stress can lead to yet another decision investors may come to regret: Selling before (they believe) the market falls even further.
The reason: Unloading an investment that’s worth less than you paid for it turns a “paper” loss into a real one. And that can have consequences you didn’t intend.
So before you make a move, it pays to understand the concept of “unrealized” and “realized” losses (or gains) and how they might affect your finances.
Realized and unrealized gains and losses
When you invest in stocks — through individual companies or through mutual funds or ETFs — you buy shares. The value of those shares can change for a variety of reasons. But in general, when broad swaths of the market rise or fall, those shares follow suit.
While you own those shares, any gains or losses you experience are “unrealized” — they show up on your statement, but not in your bank account. They’re not exactly meaningless. But other than affecting your ability to borrow against them (if you have a “margin” account at a brokerage), and maybe your stress level, they don’t mean much in the long run — you’re still invested, and your investment could still rise (or fall) in value.
But once you sell, you “lock in” your losses (or gains) and they become “realized.” Besides getting paid, in the short term that means you’ll owe federal capital gains tax (if you made money) or can deduct the loss when you file your tax return.
Long term, the sale could have a much bigger effect on your financial health. If you’re investing for a far-away goal like college or retirement, your investment won’t be there for the rebound. That’s important to know because, historically, the market’s best returns have come on a relative handful of days. If you miss those, your losses will be even harder to make up.