On the Street wrote:
Investor wrote:You lose nothing until you sell.
Klondike5 wrote:
Really?
So when your 401(k) equity holdings drop from $1 million to $450,000, in your mind you have lost nothing?
Investor wrote:
That is correct. Gains and losses are not realized until investments are sold. That's Investing 101.
100% correct.
I have been hesitant to answer such drivel, as it has seemed to me that nobody could actually believe this nonsense about 'You haven't gained or lost anything until you sell'. But seeing folks post this stuff over and over again gives me pause. Do you actually believe something so patently ridiculous?
Well, on the off chance that some of you are not just trolling and are truly having a hard time thinking clearly about something so simple I will provide you with enough here so that if you are honest and have an IQ over 85 you will finally get it. If not, there is no helping you.
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The True Story of Mr. Hold and Mr. Sell
Let us imagine two individuals, Mr. Hold and Mr. Sell. They are identical in all ways, save for their names and their future actions. Both have invested $1M in the stock market on the very same day and in the exact same bucket of stocks. They also each have $500,000 in cash.
The market goes up for a couple of years. It goes high enough so that the identical portfolios that Mr. Hold and Mr. Sell have are now valued at $1.6M each. At that point Mr. Sell decides to (surprise!) sell his entire portfolio to realize capital gains of $600,000.
But then Mr. Sell has second thoughts and instantly plows the entire $1.6M back into the exact same bucket of stocks, the prices of which have not changed so that he again holds the exact same portfolio of stocks as before (the exact same portfolio that Mr. Hold still holds). (We are going to ignore transaction costs here since they are trivial and, more importantly, irrelevant to the simple logic involved).
Of course, Mr. Sell did in fact sell his portfolio and will owe taxes on his gains. Let's say, for the sake of argument that his tax liability upon selling will be $100,000 and that he will pay for this out of his $500,000 in cash.
So now, what can we say about Mr. Hold and Mr. Sell?
First, what is indisputable:
Mr. Hold now has a portfolio consisting of $1.6M in a basket of stocks and $500,000 in cash.
Mr. Sell now has a portfolio consisting of $1.6M in the identical basket of stocks plus $400,000 in cash (he has sent off $100,000 to his friendly neighborhood tax man).
Thus, Mr. Hold is momentarily $100,000 richer than Mr. Sell (but with a lower basis for his stock holdings which will have as yet undetermined tax consequences down the road).
What else can we say about Mr. Hold and Mr. Sell?
Well, according to several folks here we can say that Mr. Hold has made nothing (remember, you have made nothing until you sell). Meanwhile Mr. Sell has made $600,000 (remember, he has sold - before buying back - and therefore, according to LetsRun logic he has indeed made real money, $600,000 before taxes to be exact).
Now, does that not strike you as odd?
Mr. Hold is $100,000 richer than Mr. Sell. And, aside from their difference in cash on hand they now own precisely the same portfolio of stocks. This, while Mr. Sell has made $500,000 (after taxes) and Mr. Hold has made exactly zero (after all, you have not made anything until you sell, right?).
This story has been brought to you as a public service by the same guy who has repeatedly demonstrated that intentionally dollar cost averaging is a tool fit only for fools. I truly feel for those of you for whom this story was necessary. And for those who still cannot connect the dots from here, there is no hope - I will pray for you (figure of speech).