Camille Van Vyve
15 Mar 2024
Can you lose everything in the stock market?
This is what puts off most of those who are reluctant to invest in the stock market: the risk of losing everything. It would be wrong to say that this risk does not exist. But how likely is it to materialize? Are there safeguards or, on the contrary, particularly dangerous behaviors? Let’s recap.
Negativity bias and “black swan”
“The stock market is far too risky!”, is something you have been told many times. Of course, investing in the stock market is not without risk. There are several kinds, those involving a total loss being rather unlikely – this is the famous “black swan” of the economist Nassim Taleb. Moreover, part of this belief of "reckless risk" is undoubtedly linked to certain cognitive biases, in particular the negativity bias which reinforces negative experiences or information in our minds. So, what risk(s) are we talking about exactly?
Market risk: the basis
The price of a stock quoted on the stock exchange varies every day under the effect of supply and demand and various market parameters, such as the price of oil, the policies announced by the major central banks, the behavior of the main currencies.... These fluctuations are qualified as market risk: it is the most common risk on the stock market. Fortunately, market risk will never cause you to lose everything. In reality, it's mostly noise that you should ignore if you're investing for the long term.
Crash risk: don't panic
We speak of a stock market crash to designate a collapse in share prices on one or more financial markets. In this case, many different assets and sectors are affected: this was the case in 2008 during the subprime crisis in the United States, after the attacks of September 11, 2001, during the bursting of the internet bubble in 2000 … In this kind of context, even on a diversified portfolio, the temporary depreciation can reach 30 or 40%. Although highly publicized, crashes are far from the norm. And above all, it is often after a crash that the stock market has its best years of growth… to finally reach new heights.
Risk of bankruptcy: the hassle
If you buy stock in a company and it goes bankrupt, chances are you will lose all your money. This is the most obvious risk, but not the most likely. Firstly because the bankruptcy of a company listed on the stock exchange is a rather rare event – we remember in particular that of the investment bank Lehman Brothers in 2008, probably one of the worst in history, that of the giant Nokia… But above all because this risk can be very easily counteracted by diversifying your investments.
We don’t avoid risks… we manage them!
In terms of risk management, diversification (of asset classes, sectors and geographies) is therefore an absolute must. Then, you will have to ensure that you maintain your target allocation over time, i.e. the stock/bond mix defined according to your risk profile. Finally, to minimize the risk of bad timing and reduce the impact of stock market volatility, you could decide to smooth your investments over time (that is also called Dollar-Cost Averaging).
Go broke with the leveraging
When you buy real estate, you often do so on credit. You take out a loan which generally represents the largest part of your acquisition. If the property appreciates over time, the added value generated will be even greater: this is called the leverage effect. Although these mechanisms are not accessible to everyone on the stock market, there are investment strategies that allow you to go into debt to invest beyond your initial outlay. Which multiplies the potential gains…or the potential losses. Beware, danger: the leverage effect can therefore also transform small fluctuations into total losses, and more.
Go broke with short selling
Short selling involves selling a stock that you do not yet own. The objective of this strategy is to be able to buy it later at a lower price. But if the value of the security goes up, you will be forced to buy it at a higher price, materializing a loss. In a scenario where the title would only go up, you therefore expose yourself to a substantial loss, even greater than your assets.
Can you lose everything in the stock market?
One thing is certain: there is no return without risk. Another is almost equally certain: in the long term, the stock market as a whole only goes up. In the short and medium term, variations are the norm, and they are sometimes violent. The key is to respect the basic principles of risk management, to keep your investment horizon in mind, and above all, not to opt for strategies that do not correspond to your risk profile. In doing so, you might lose, but never lose everything. And above all, you maximize your chances of winning.