Nobody likes to lose money on investments. But inevitably, most of us will make at least one bad investment decision in our respective lifetimes, and when that happens, we're faced with a choice: risk parting with even more money, or cut our losses and move on.
Now, to be clear, it's rarely a good idea to rush to dump an investment the moment its value begins to decline. On the other hand, if you're looking at a consistently poor performer in your portfolio, it often makes sense to get rid of it and minimize the damage.
Of course, if you're the glass-half-empty type, it's easy to sit around bemoaning an investment loss. But if you'd rather spin things positively, here are three good things that can come out of a realized loss.
1. Tax benefits
Any time you make money on an investment, the IRS is due its share during the same tax year you collect that profit (the exception being money held in a retirement account, like a 401(k) or IRA). This means that if you sell an investment held in a traditional brokerage account for more than what you initially paid for it, you'll owe taxes on that gain. And that's precisely why it often pays to take investment losses.
Any time you take a loss on an investment, you can use it to offset an existing capital gain. So if, for example, you sell a certain stock at a $2,000 profit, but then take a $2,000 loss that same year, you'll cancel out that gain, thus eliminating the tax bill it otherwise would've generated.
And that's not the only benefit you'll get from an investment loss. If your net losses for a given year exceed your total gains, you can use your remaining balance to offset up to $3,000 of ordinary income. This means that if you sell an investment for a $5,000 loss but have only $2,000 in gains to show for it, the remaining $3,000 will work to reduce that much in taxable income.
But wait -- it gets better. If your net loss for a given year, after factoring in gains, is more than $3,000, you can carry it forward to the following tax year. At that point, the unused portion of your loss will first be used to offset capital gains, and will then be used to offset regular income. Or, to put it another way, a loss you take today will buy you more financial flexibility in the future.
2. Better investment opportunities
It's hard to let a bad investment go and lose money in the process. But if you take the proceeds from the sale of that investment and apply them to a better opportunity, you might end up not just compensating, but coming out ahead, fairly quickly.
Imagine you bought a $10,000 bond at face value, only the issuer has since stopped making interest payments and the value of that investment has dropped to $7,000. Since you're not getting anything out of that bond, it pays to unload it if things are unlikely to improve any time soon. And while you will take a $3,000 loss by selling it off, you'll also free up $7,000 to invest elsewhere. Now, imagine you take that $7,000 and buy yourself shares of a company whose stock price doubles over the next year. Suddenly, you'll be sitting on a net gain over the course of both transactions.
3. Peace of mind
One reason why so many people shy away from investing is that they're afraid of losing money. But holding onto a bad investment is like sitting on a ticking time bomb, so if your goal is to sleep better at night, it pays to minimize your losses and enjoy the peace of mind that things didn't get any worse.
Also, remember that it's easier to account for an actual loss than a hypothetical one. Once you take a loss, you'll know what dollar amount you're working to recover from, and that's a lot more practical than factoring an unknown figure into your finances.
Though taking losses on investments isn't ideal, it's also not such a bad situation to be in. If you've been hesitant to unload a loser in your portfolio, consider the benefits of dumping it sooner rather than later.