WHEN GOOD INVESTING GOES BAD
when the market goes down, equity investment values go down. To most investors, this is troubling. To others, it’s not. This is why: The loss is only on paper. I have clients who will call during a down mar- ket and tell me that they are losing money and that they don’t want to lose any more. What they fail to understand is that there is no real loss until they sell, or liquidate, their position in the security.
A few months after taxes for the year 2000 were due, I met with a married couple who are clients of mine. They, like others, were concerned about the stock market’s performance. They told me that they had lost money on their funds and wondered why they couldn’t claim the loss for their taxes. I took a look at their account statements and saw that they hadn’t taken any money out of their nonqualified (regular) accounts; they had only taken money out of their IRA accounts. I explained to them that because the loss for their nonqual- ified accounts was only on paper, they couldn’t claim it. Plus, the loss they showed for their IRA accounts couldn’t be considered because the money was put in there on a pretax basis. I told them that if they had sold some of their nonqualified mutual funds during the year, they would have been able to take the loss.
For example, you purchase $40,000 of the XYZ Value Fund. After a few quarters of positive growth, you receive your statement and see that your investment is now worth $45,000. However, then the market begins to decline. Your next statement shows your invest- ment value at $42,500. This is still a net paper gain of $2500 from your original investment. But then the next quarter shows a drop of $4000, bringing your investment value down to $38,500. You have a paper loss of $1500. This isn’t an actual loss until you sell your fund. If you were to cash out of your position at that point (thus, receiving $38,500 for your fund), you would have an actual loss of $1500. But if you don’t, and you hold your position in the XYZ Value Fund, you have only a paper loss.
Initial investment = $40,000 Market goes up; account value = $45,000—paper gain of $5000 Market goes down; account value = $42,500—paper gain of $2500 Market goes down; account value = $38,500—paper loss of $1500 Sell the fund for $38,500—actual loss of $1,500