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By Adrian Mastracci
North Shore News
Business Section, “Loose Change”
Sunday, August 26, 2001
Watching investments that don’t measure up to expectations
is a traumatic experience. It usually means that you were wrong
about the investment analysis.
Making portfolio selections is not about always being right. Part
of investing is about coming to grips with the prospects of being
wrong. It is important to admit that you were wrong, and equally
important to do something about it.
The doing part is difficult for many. The reasons for your loss
are not important. The question is whether the loss is sufficient
reason to reduce your investment position. If your strategy is not
delivering on expectations, it may be time to take the loss, and
move on.
In order to understand the impact of a loss I’ve developed
the table below called “the threshold of discomfort”.
Threshold of Discomfort
Say you lose 30%, you have to gain 43% just to break even. If you
lose 60%, you have to gain 150% to break even. That's quite a climb!
This applies more strongly to portfolios holding individual stocks.
What is most detrimental is not incurring losses; rather it is keeping
them too long. In the last 18 months alone, many stock prices have
declined more than 60% from their highs, some more than 90%.
Many investors cannot bring themselves to sell a loss position,
often adding to it with the hope that it will bounce back to breakeven
before selling. Often, this allows the losses to run wild. Astute
portfolio managers have the nerve to admit being wrong.
Here is the approach to containing the impact of investment losses:
- Don't get married to your investments.
- Establish your threshold of discomfort from the table.
- Investment merits of the securities are always primary considerations,
tax implications are secondary.
- Judge your securities on their appropriateness to achieve your
long-term goals.
- When the fundamentals change, take the medicine and select other
investments.
- It is less painful to bail out, rather than to insist that you
are right and then bail out later with bigger losses.
Investing is a game of probability. Yes, you can bail out too early
on a losing investment. However, successful investing is about future
expectations, not about hindsight.
Each loss that you incur started out as a very small loss. If you
choose to ignore the situation, the painful problem does not usually
go away.
Be diligent about focusing on your losses. Your first loss is more
often than not your best loss. The medicine hurts, but your investment
experience will improve.
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