How to Deal with Losing Stocks?
A Portfolio with Losses
I met up with an old friend recently, and he wanted to seek my views on his portfolio. After taking a look, I noticed that he was holding onto more than 30 stocks and many of them were in the red (losing $$) despite the recent years of bull market. I also noticed that most of the stocks were from poor businesses (in my view), and some of the stock price have dropped by more than 70% (ouch).
If you are my friend here, what would you do?
You have two options.
HODL or SELL.
If you are a HODL (hold on for dear life), you might be thinking – “The stock price is already so low, what do I get from selling it, I will just keep it” or “I will sell the moment the stock price bounce back and breaks even, so I will wait and be a long term investor”.
Losing Sucks
Let’s face it – Losing sucks. Nobody likes to lose. In fact, studies have shown that humans are very afraid of losing. We would rather not lose than to win! Humans tend to “feel” more pain when facing a loss as compared to gain, even when the amount of gain and loss are exactly identical.
For example, if you see a dollar coin on the floor, you may not pick it up (depending on the situation, of course), but if the same dollar coin were to drop from your pocket, studies have shown that you are most likely going to pick it up (and it happens to me too!)
Therefore, when facing with a potential loss of their investment, people go to great lengths to avoid it being realised. They will convince themselves that it is just a paperloss, believing that the price will bounce back eventually so they hold onto the losing stock.
However, this behaviour often blinds investors of the fact that a poor investment could go a lot worse. While it may be a 50% loss now, it could possibly go to 90% or even 100% resulting in a complete loss of capital. More importantly, this behaviour also comes with an opportunity cost because the remaining amount of capital from a losing stock may yield better returns when used in other investments.
So How to Deal Losing Stocks?
Start Afresh
One of my best ways to deal with losing stocks is to start afresh.
First, you need to pretend that you have not bought the losing stock, and you are now given a second chance to reconsider.
Second, you need to ask yourself the following question –
Will I still buy the stock at this price?
If you are still confident with the company’s business and at this depressed price, you will still buy the company’s stock. Then yes, you should hold onto the stock.
However, if you hesitate (even the slightest bit) in buying the stock again when you are given a second chance, you need to SELL. Don’t think about waiting for the stock price to bounce back and breakeven.
Because you have just shown that this is a business that you would not want to be involved with when given a second chance. And the important fact is this decision remains valid regardless of your current investment. A bad business remains bad no matter who is investing in it (yes, including you).
The Most Important Benefit
The main goal of every investor should be to maximise your profits and minimise your losses, and the exercise above helps you to do just that by removing bad businesses from your current portfolio.
Perhaps more importantly, it will reinforce the correct investing behaviour in you. This will prevent you from making even more losses in the future because of our loss-adverse instinct in our primitive monkey brain. And once you have sold all the bad businesses in your portfolio, you will end up with only the good ones! What a great position to be in.
Don’t be afraid of making mistakes, just don’t repeat them.
See you soon!
Investing Always,
Pete
