Understanding Capital Loss: Meaning, Causes, and Impact on Investments

Every asset that you own for personal or investment purposes is called a capital asset. Homes, cars, stocks, bonds, and mutual funds are some examples of capital assets. These assets are purchased by companies and organisations for their daily business operations to ultimately generate revenue over a period of more than a year. The profit or loss associated with it is determined from the sale of those assets. However, your investment journey may not always be smooth. It has its own ups & downs and is inevitable, even though everybody wants to see their investment choices flourish. This makes it important to have a thorough understanding, as it will help you make better choices and decisions.

Table of Content

• What is a Capital Loss?
• What Causes a Capital Loss?
• Types of Capital Loss
• Impact of Capital Loss on Investments

What is a Capital Loss?

It refers to the reduced worth of an organisation or company’s capital assets or other forms of investments. Losses in general are incurred when you sell something at a relatively lower price than the purchase price. Likely, a capital loss is incurred when an individual or company sells its investment for less than what they purchased it for. Capital gain, on the other hand, counterbalances capital losses to provide relief to businesses and entities alike. Capital losses can take different forms.

What Causes a Capital Loss?

The fluctuation in the market value of assets due to economic factors, market conditions, inflation and other specific events can cause a capital loss. In financial planning, capital losses play a significant role as they can counterbalance capital gains. This, in return, reduces the overall tax liability. It is of utmost importance that investors calculate capital losses, as it will help them to make well-informed decisions regarding their portfolios, identifying investments that are underperforming so that their tax obligations are managed effectively.

Suggested Read: 6 Key Investment Concepts Beginners Should Know

Types of Capital Loss

The holding period for an investment or a capital asset refers to the duration between the acquisition and subsequent sale of the asset. Calculating the period is important for taxation purposes, which is concerned with capital gains and losses. There are two categories of capital loss, based on the length of the holding period.

• Short-term capital losses: They are incurred when assets are sold within a year of purchase. These losses often occur in volatile markets, where rapid changes in asset prices can cause substantial short-term losses.
• Long-term capital losses: This type of capital loss is incurred when assets are sold after holding an investment for more than a year. Their cause is a result of poor performance in the market and can affect long-term investment strategies, as the asset's intrinsic value decreases over time.

Impact of Capital Loss on Investments

Understanding the impact of capital loss on investments is important for building strategies that can mitigate its impact. Some of these strategies are:

Long-term investing

To outrun short-term market fluctuations by recovering from losses over time involves proper planning of a long-term investment.

Diversification of portfolio

This strategy involves spreading your investments across different classes of assets and funds. Doing this can help in mitigating the impact of losses confined to a single area.

Set goals

Set goals that are practical and achievable, in the short-term as well as long-term. Doing this will help you in decision-making that is backed by logic more than emotional reasons in times of market fluctuations.

Stay informed

Keeping up with recent market trends, news, and current affairs will assist you in making timely investment decisions. Evaluate your portfolio's performance regularly, so that you can identify potential capital losses early on.

Tax implications 

Considering tax implications and their consequences related to your investment decisions, and how one can benefit from capital losses.

By staying informed and making strategic choices, investors can navigate the complexities of capital losses. Managing capital losses effectively can assist investors in working towards their long-term financial goals. Investing in mutual funds with Muthoot Finance gives you access to professional fund managers, high liquidity and flexibility with small amounts over time through a SIP (Systematic Investment Plan).