Investing can be a scary prospect, especially if you don’t know much about how it works or what the risks are. A common question we hear is, can you lose more money than you invest? The simplest answer is that it depends on 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 never lose more money than you put in. However, there are several advanced ways of investing where you could lose more money than you invest. But for most investors, the most your account will fall to is zero, which means that you could only 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 why Wealthify included a diverse mix 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 use several advanced techniques, which could lose more money than you invest.
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, but if this doesn’t happen and the price rises 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, but a typical example would look like this. You choose to short 100 shares at £10 – giving you £1,000 worth of shares, which is also the maximum profit you can make. Shorting then means that in the future you’d owe the lender 100 shares, so if the price of each share fell from £10 to £1, then you’d owe the lender 100 shares, only costing you £100 and giving you a £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.
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 a 45% gain on the £550,000 the 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, the investor’s loss would be £350,000. This would be just shy of 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. This aims to prevent investors from losing more than they put in. However, as the markets aren’t certain, this does have the potential to happen, and it could result in large repayments being required.
Can you lose more money than you invest in shares?
If you’re using your own money 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, then you can lose all your money when investing.
Ways that could protect 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 diversifying your investments – ‘don’t put all your eggs in one basket’ is a phrase that’s been used for centuries, and it applies to investing perfectly. Instead of banking on one investment to pay off and risking everything if it doesn’t, consider spreading your money around by choosing a 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 investing for the long term – While some people might find day trading attractive, investing for the long term could help you ride out any market 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!
- Consider how much you invest – there’s a risk with investing that your money could reduce in value. Because of this, you may want to think about how 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 take against the level of potential reward.
- Trust the experts – investing doesn’t have to be difficult, with robo-investors like Wealthify, you can let the experts do the research, buy and sell on your behalf, and carefully 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 choices based 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.