What does ‘locking in your losses’ mean?

February 24, 2023

When markets are fluctuating, or asset (such as shares) prices are outright falling, the advice is to stay put to avoid ‘locking in your losses’.

But what does that really mean? And what do you need to know to avoid getting caught?

Here are some key things to know.

What does it mean?

When markets are down, it decreases the value of your investment – whether that’s a portfolio of shares, a KiwiSaver account, or your house.

But in reality, that doesn’t really matter at all if you weren’t planning to sell anyway. Until you sell and liquidate your investments (for example, by withdrawing your KiwiSaver funds or moving to different type of KiwiSaver fund), the loss is only ‘on paper’.

However, if you decide that you’ll sell those assets when the value is low, you turn a hypothetical drop in value into a real loss of money. You can’t ride the market back up when it recovers because you’ve sold the asset. That’s locking in your losses.

How does it happen?

The most common way this happens is when people become worried about the falling value of an investment such as their KiwiSaver decide to move it to something “safer”.

But when they sell their growth fund at the bottom of the market, for example, and shift to a lower-risk fund, they take all the loss that has happened to that first fund and invest what is left in different assets that may not deliver as good returns over the long term.

What is the better course of action?

The best way to avoid this situation is to have investments that match your risk profile from the outset. That means that you’re invested in things that suit your investment horizon (how long you have until you plan to access the money) and personal appetite for risk. If you know you’re invested the right fund for your circumstances, it becomes easier to stay the course, even when values bounce around. And staying put is how you avoid locking in your losses.

Market movements are normal

Movements in price are normal and all part of the investing process. Markets tend to move in cycles, and some periods of time may be more comfortable for investors than others. But there are always investment opportunities and over the long term, investment asset values do tend to appreciate, overall.

Diversification is your friend

You can help to manage some of your risk exposure through diversification. Markets aren’t homogenous and spreading your investments will usually mean that one part is doing better than another at any given time.

You might diversify by choosing different asset classes, or maybe investing with a geographical spread. As investment advisers, we can help you understand how to do this effectively.

Does this mean no switching at all?

Sometimes the “don’t lock in your losses” message gets interpreted as “stay put in all your investments when things are volatile”. This isn’t necessarily true.

There can still be good reasons to move an investment, especially if you’re moving to something with similar exposure – such as from one KiwiSaver growth fund to another. If you’d like to talk about repositioning some of your investments, we can help you understand the implications of this.

Like to talk?

If you’d like to discuss your investments’ performance, or you have any other questions about investing, get in touch with us today. We are here to help.

The information contained in this publication is intended for general guidance and information only. It has not been personally prepared for you. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult with us before making any investment decision. Historical market performance may not be indicative of future market performance.