Investing can be a scary prospect, especially if you don’t know much abouthowit works or what the risks are. A common question we hear is, can you lose more money than you invest? The simplest answer isthat itdependson how you’re investing.But this requires a bit more explanation.
Can you lose more money than you invest?
If you’re investing with Wealthify, then you will neverlose moremoneythan you put in. However,there are severaladvancedwaysof investing whereyou couldlose more money than you invest. But for most investors, themost your account willfalltois zero, which means thatyoucouldonly ever lose what you put in.So, for example, if you bought a share in a company for £10 and that company goes bankrupt, that share may then be worth £0,and you’ll have lost £10. This is just one of the many reasons whyWealthify includedadiversemix of investments in your plan, to help spread the risk and reduce the chance of you losing all your money due to one poor investment.
Ways you can lose more money than you invest
That said,professional investors useseveral advanced techniques,whichcould losemore money than you invest.
Short sale
For example, if you were using a ‘short sale’ which is where the seller borrows the stock (or the money to buy it) from a broker-dealer who has a sell order, which is an obligation to buy the stock back in the future. With short sales, you don’t put up all the money, just a portion of it – so you may put forward £2 for a £10 share for example. The aim with this technique is to hope that the price of a stock will fall, butif this doesn’t happen andthe pricerises then you could lose more money than you initially invested as you’d have to return the shares or the money borrowed.
This can be a bit complicated,buta typicalexample would look like this. You choose to short 100 shares at £10 – giving you £1,000 worth of shares, which isalsothe maximum profit you can make.Shorting thenmeansthat in the futureyou’d owe the lender 100 shares, soifthe price of each share fellfrom £10to £1,then you’d owe the lender 100 shares,onlycostingyou £100 andgiving youa £900 profit.
But if the price of those shares increased, you could see significant and potentially uncapped losses. These can be calculated by subtracting the price at which you sold your shares short at from the price they’re currently at and multiplying by the number of shares you have sold. For example, if the price of shares doubled you would lose £2,000 as (£20-£10)*100 = £2,000. And the more the price of the shares goes up, the larger your losses would be.
Leveraged investment
Using leverage is another technique that professional investors may use to provide greater potential for profit.It can also result in greater losses, although typically not more than you put in. In essence, leveraging allows you to use borrowed money to invest a greater amount and therefore amplify your results. As you can increase the total value of what you own, a larger gain will improve your input, but a decrease in value would result in greater loss.
So, for example, an investor may put in £500,000 and borrow £1,000,000 to purchase £1,500,000 worth of investments – that could be land, shares, gold, etc. Then, let’s say that the repayments on this loan are £50,000 and are due at the start of each year. If after one year the value of the investments increased by 20%, it could be sold at £1,800,000 – after settling the debt plus interest of £1,050,000,the profit would be £250,000 – which works out as a45% gain on the £550,000the investor paid.
However, had the investment lost money and sold for 20% less at £1,200,000–minus the £1,050,000 loan with interest, theinvestor’sloss would be £350,000.This would be justshyof a 64% loss on the £550,000 paid by the investor.
There are many regulations in place to prevent frivolous lending or borrowing at significantly smaller amounts to lending. Thisaimsto prevent investorsfromlosing more than theyput in.However,as the markets aren’t certain, thisdoes have the potential tohappen,and it could result in large repayments being required.
Can you lose more money than you invest in shares?
If you’re using yourownmoney to invest in shares, without using any advanced techniques to trade, then the answer is no. You won’t lose more money than you invest, even if you only invest in one company and it goes bankrupt and stops trading. This is because the value of a share will only drop to zero, the price of a stock will not go into the negative.
Because the price of shares is determined by supply and demand – the number of people wanting to buy against those looking to sell–if nobody is looking to buy then the stock becomes worthless. Investors aren’t likely to pay other people to take the stocks off them. They’ll simply cut their losses.
That said, if you invest all your money into a single place and the value of that investment falls to zero,thenyou can lose all your money when investing.
Ways that couldprotect your money when investing
There are many risks to be aware of when you’re investing, but we aren’t saying that to scare you off, we’re saying it to help you take the right actions to avoid these errors.When planning to invest, there are a number of things that you could do,which can help reduce your risk of losing all your money through poorly made investments.
- Consider diversifyingyour investments–‘don’t put all your eggs in one basket’is a phrase that’s beenused for centuries, and it applies to investing perfectly. Instead of banking on one investment to pay off and risking everything if it doesn’t,considerspreadingyour money aroundbychoosinga range of different investment types from all over the world. This way, if one underperforms,it is likely to be balanced by one that overperforms during the same period.
- Think about investingfor the long term–Whilesome people might findday tradingattractive,investing for the long term could help you ride out anymarket dips and see your investments flourish.The numbers show that if you invested in line with the FTSE100 for any ten years between 1986 and December 2019, you’d have had an 89% chance of making a gain![1]
- Consider how much you invest– there’s a risk with investingthat yourmoney could reduce in value. Because of this, you may want tothink abouthow much you invest to avoid over-stretching yourself on investments that you can’t afford.This will be different from person to person, and it’s all about balancing how much risk you’re willing to takeagainstthe level ofpotentialreward.
- Trust the experts–investing doesn’t have to be difficult, withrobo-investors like Wealthify, you can let the experts do the research, buy and sell on your behalf, andcarefully look after your investment plans. While it doesn’t guarantee you won’t lose money, it does mean you’ll have a team of experts carefully calculating the best choicesbased on plenty of research and data.
- Data from Bloomberg
Please remember that past performance is not a reliable indicator of your future results.
With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.
