Made a bad choice? Want to know how to recover from bad investment? Recovering from a brutal drawdown is onerous, but every experience can be a lesson, and every loss is, therefore a gain. The key is to follow some steps. Otherwise, people tend to make terrible choices which can lead to a disaster.
Risk is a part of investment and it is natural to incur losses at some point in your life. The reason stocks pay higher returns than any other investment, like a fixed deposit in a bank, is that their prices are subject to the fluctuation.
Nevertheless, It is frustrating and painful because you just lost the money you have worked hard for your whole life. It brings out a lot of negative emotions, completely shatters us, we lose hope, and it clouds our judgment. We indeed invest in the hopes of making a profit, but even the greatest wall street investors can make bad investments. It is important to cut losses as quickly as possible.
1. The Common Mistakes Made By Investors
The common mistakes made by beginners are given below
1.1 No Planning and Personal Bias
Investors make investments based on opinions expressed about a firm. They should instead evaluate the business. If they make investments impulsively, they don’t have any goals and purchase random securities. Hence they are more likely to lose their money.
Sometimes these rookies get attached to a company or sector. They don’t get rid of these loss-making securities hoping it will turn around. They lose good money chasing after the bad.
It is essential to set a limit for losses. Most trading platforms provide a stop-loss feature.
1.2 Short Course
Most investors invest money they cannot afford to lose. They panic when their investment is in red. They don’t let the market run its course and end up selling the asset below the cost. They should plan and allocate their investments for both short-term and long-term goals.
1.3 No Diversification
Investors have invested money in similar securities. Their investment in a particular security or asset is should be a small percentage of their portfolio. This will balance the risky and safe assets and reduce volatility. Therefore one bad investment results in a complete loss of capital.
They make investments without any investment strategy, risk management plan or proper knowledge. Thus they lose money.
2. Steps in How to Recover from Bad Investment
Now we discuss how to recover from bad investment. The steps to recover from bad investment are mentioned below.
2.1 First Step
The first step in recovering from a bad investment is always taking time to let all our negative emotions dissipate so that we can make rational choices. It is an instinctive reaction to get hysterical and want to make rash choices about our investment. This is the drawdown effect.
It is important to avoid the drawdown effect at all costs. What happens is when we lose our money, it makes us panic. While wondering how to recover from bad investment, the investor loses sight of what’s important, affecting their thought process. They adopt an all-or-nothing approach and become greedy. They try to make a profit instead of limiting their loss. This turns a small loss into a chain of losses. It can result in portfolio heat.
2.2 Second Step
The next step is to accept the situation and take responsibility for our actions. We should not shrug and put the blame on someone else, condemn the market condition, or curse our luck. It is important to evaluate the circumstances.
It is also necessary to ensure that the losses are critical and not just fail to meet some unrealistic standards. Some investors claim to pay 30% per month, but they put a lot of effort into researching the market. Less good is not equivalent to bad. It is a success even if your return is just 5%.
2.3 Third Step
It is important to determine the main trigger behind the investment losses. Stocks are always subject to risk. The investor should assess the losses and ask whether the downfall is specific to a company or an overall return decline in the market.
2.4 Fourth Step
The next step in how to recover from bad investment is to create a viable strategy. Your priority should be to avoid getting into such a situation again. Risk management is crucial. The four questions you should examine are:
- What mistake did I make in choosing the investments?
- What should I do to limit the losses and avoid future losses?
- What adjustments should I make in my strategy to steer clear of investment losses in the future?
- Is my new strategy effective and reliable? Research well to know about more common investment mistakes and how to secure profits.
2.5 Final Step
The fifth and final step is to take baby steps and keep assessing. Our focus should be on learning from our mistakes and not just making a profit. A temporary loss can result in a gain for a lifetime if we focus on developing our investment skills and understanding the psychology behind trading in the stock market.
3. Some Ways to Bounce Back
Some actions that could be taken to recover money are:
3.1 Selling the Stocks
If there is no scope for a stock to recover to its initial high, it is better to sell it to minimize losses. It is important to evaluate the company to find out whether to sell a stock or not. The investor should study the company’s cash flow, management, earnings, dividends, competitors, and prospects. They should cut loose the stocks of companies with negative returns and no future.
3.2 Average Down Strategy
Investors buy the stock at a lower price to reduce the average cost of all stocks. For example, if the price of the stock was initially $100 and now it is $50 and an investor bought 50 shares at both prices, the average price is $75. The investor will gain if the value of securities exceeds this average cost. It is an effective strategy for long-term investments in safe options like index funds or blue chips.
Do Not Panic Sell Or Panic Buy
If you are in for a long time, you should avoid panic selling and stick things out. Sometimes a company might underperform for a short period, and it is best to be patient and wait. If you sell your losers, you lock in the loss forever.
Especially with big players in the market like Apple, Meta, and Microsoft. Chances are that a big firm will return stronger than a 90s trend. Warren Buffet says it is better to buy the shares of great companies and hold them forever. For example, towards the end of 2018, the stock prices of Apple dipped low, but soon they rose from the ashes.
Panic buying is also dangerous. Using the average down strategy for blue chips and large-cap stock that you will hold for a long period is okay. However, you might be throwing away your money if you panic buying speculative startup stocks. No one can guarantee that such stocks won’t dip lower in the next quarter.
3.3 Tax Loss Harvesting
This is the best way to gain something out of a loss. The underlying idea is to cut loose the stock whose price has declined to record a capital loss which can be used to offset against capital gains or even ordinary gains up to a limit and carry forward the loss to offset in the future. You can then replace it with a similar investment.
However, you cannot reap the benefits if you buy and sell the same or substantially correlated stock within 30 days. This is the wash sale rule. It is advised to replace the stock with a mutual fund or ETF.
3.4 Exit Plan
It is recommended to have an exit plan for every stock. The investors should decide their target price and lock in their profits and losses when the stock hits that price. It will help to make rational decisions. This is for investors who don’t wish to stay invested for the long term.
3.5 Risk Management
Managing risk is essential. Even if you make mistakes, you can get good out of a bad situation in the long run by managing the risk efficiently. It helps to minimize volatility, earn good money and reduce risk.
The most important technique for managing risk better is diversification. You have probably heard, “Don’t put all your eggs in one basket.” Expert suggests that an investment in one security should be at most 5 % of the portfolio. With proper allocation and a diversified portfolio, one bad investment’s impact significantly reduces. You might be able to withstand the bear market and gain in the future because there is a balance between risky assets and secure investments. Their capital won’t wash away because of one bad investment.
Owning various assets and investing in different sectors can help balance the portfolio’s risk profile. One can also invest in firms from other countries and alternative assets, for example, commodities, real estate, bonds, etc. Mutual funds, ETFs, and fractional share investing are great choices.
There are some scenarios in which the investor can recover money through legitimate actions. Suppose the company or the financial institution goes into bankruptcy. If the firm is a fraud, or there is a dispute with the broker, there may be some legitimate avenues to recover money. However, there is no legal way
3.6 Arbitration and Mediation
An investor can claim arbitration or file a petition for mediation through the Financial Industry regulatory authority. You can also file a complaint to the Securities and Exchange Commission. You can file this if there is some dispute regarding the business activity of the broker. Brokers are professionals and responsible for giving clients advice according to their needs and situation. You can also complain to the SEC, Securities and Exchange Commission.
Arbitration is a simple, cost-efficient and quick option compared to going to court. An attorney should be hired for legal procedures and advice. It is important to meet certain criteria, like the alleged act should have occurred in the previous 6 years.
The Securities Investor Protection Corporation safeguards investors against loss due to bankruptcy of the brokerage firm. If the cleaning firm, after becoming insolvent, cannot return the investors their investments, SIPC is responsible for providing limited protection. It also provides coverage for unauthorized trading in an introducing firm. But there is no provision to recover funds lost due to bad choices about the investment.
3.8 Fair Funds and Disgorgement Plans and The Enforcement Action
Under the Sarbanes-Oxley Act of 2002, SEC has the authority to apportion financial penalties to investors who have lost money. They have a list to determine in which cases the injured investor will be provided relief.
SEC and FINRA also have the authority to provide financial restitution under enforcement actions. They also have a list of eligible cases.
Sometimes the bank also becomes insolvent. If this happens, you lose all the money you had deposited in the bank. There is a body called the Federal Deposit Insurance Commission, which provides coverage for regular bank accounts. In case the bank goes bankrupt, you can reclaim the amount up to a limit of $250,000 from FDIC.
An investor can also file for class lawsuit action. There is a procedure for recovering money lost when a company goes bankrupt. Courts handle it. Most firms have the plan to return a portion of investors’ money.
The recovery of money invested in companies that went was fraudulent or, in most cases, the loss due to bad investment and loss associated with stock market risk is difficult. Investors can also seek professional services. If they cannot afford expensive assistance, they can get help from Robo advisors. However, recovery is not the end. It is more important to have growth and gain knowledge.