Learning To Sell Your Losers – No Stock Owes You Money
Most investors have a very hard time selling a stock that has declined.
Now I don’t advocate always selling losers. Sometimes, a lower price means that the stock is even more of a value and it would be appropriate to average down.
However, the more normal case is that the stock price has declined due to some bad news or change in outlook. (And bad news almost always seems to be followed by more bad news.) In this case, the original reason for buying the stock has changed. Often the investor would not be a buyer at the new lower price. And yet investors stubbornly hold on these kind of losers.
We don’t want to sell at a loss. Implicitly we are saying that this stock “owes us money” and, damn it, we aren’t going to sell until we get it back.
Another reason that we don’t sell these losers is that we can’t stand the thought of the regret we would feel, if the stock actually did recover after we sold it. In that situation it feels like we lost the money twice.
When we hold a loser we can blame management or our stock advisor for the loss. This is comfortable. But if we sell the loser and it happens to go back up, then we feel stupid and can only blame ourselves.
A good rule to follow is that if you absolutely would not buy the stock today if you did not already own it, then you should sell it.
Holding on to losers, that we would not buy today if we did not already own them, is a comfortable state of denial. This is not the same as when we hold onto stocks that we truly think are under-valued.
Learning to Sell Losers:
Investors need to learn to focus more on doing what is right for their overall portfolio, not on how they are doing on individual stock picks. The goal is to make a return on your portfolio, not to win on every stock pick.
Since the natural human tendency is to hang onto the losers, we need a set of rules that virtually forces us to sell them.
For example we could adopt a rule that we will not have more than say 10 to 15% of our money in stocks that we would not be prepared to buy more of today. We could also adopt a rule of not paying attention to what a stock does after we sell it.
My own portfolio has not done as well as my Strong Buy picks. The reason is that I have held onto stocks that I no longer consider to be a Strong Buy or even a Buy and therefore I have not had enough invested in my Strong Buys. I now intend to correct this by forcing myself to have at least 60% of my equity portfolio in my Strong Buys at the start of each year. Another 30% can be in Buys and with the last 10% I will allow myself to stay in some loser stocks that I just can’t seem to give up on. This way I will force myself not to become over exposed to hanging onto any past picks that I am no longer confident in.
I will attempt to always remember that no stock owes me money, no matter how much I have lost on it.
If I sell a stock, at a loss, that I no longer think is a Buy, I will consider that to be a good decision and I will not concern myself with what the stock does after I sell it. If it does happen to recover, then that is a bad outcome for me, but that does not change the fact that it was a good decision to sell at the time, given the information in front of me.
Investors have to learn to stop blaming poor managers and bad advice for their losses. Investors must take the responsibility to avoid bad managers and bad advice. This includes learning to sell losers when you realize that the company is being ran by bad managers or that the outlook is negative, that the original reasons for owning the stock are no longer valid, or that the stock is over-priced for any reason.
Taking Out The Trash
Investors should identify all of their stocks that are down more than about 15% from the price they paid or from their recent high.
Those that you are sure that you definitely would not buy at this price if you did not already own them should be sold.
Those that you are convinced are still good value should be kept.
Those where you are not sure should be investigated further and then put into
one of the first two categories above.
Shawn Allen, CFA, CMA, MBA, P.Eng.
March 29, 2003