Many investors see their investments as an indication of their personal success. If investments are up, you’re a success. If there’s a loss in the portfolio or one of your holdings isn’t performing well, you see it as a bad reflection on you.
But you might be missing some opportunities if you take those losses or lesser performers as a poor reflection on you.
Studies have shown some trends that might be instructive about investor behavior about losses. One is that investors generally have negative feelings about losses that are greater than the positive feelings about gains. In other words, investors generally feel worse about losses than they feel good about gains. These studies also show that investors are often quick to cash in on their gains and slow to realize their losses.
An adage from investment professionals is that “your first loss is your best loss.” This is true more often than you might realize. As investors, we often think that if we just hold on to a losing investment long enough, it’ll get back to the value we paid for it. For those who invest in individual stocks — rather than mutual funds or exchange traded funds (ETF) — waiting for an individual stock to climb back or even become a big winner might not be worth the wait. In fact, there are some tax benefits for selling an individual stock when it’s worth less than what you originally paid for it. That’s not to say that anyone should center an investment strategy around buying lousy individual stocks for the tax benefits. But if you bought an individual stock and it’s not a winner, take your loss and move on.
Shifting how you look at losses may make it easier to take them. In corporate finance, the term “sunk cost” indicates resources – money, time, analysis — that went into a project. When analyzing whether to continue a project, the current facts and future prospects are what weigh in the decision, not the sunk costs that can’t be recovered. And with a decline in stock price, your entire cost isn’t sunk, just part of it.
Many investment professionals, including some mutual fund managers, look for opportunities to “harvest losses.”
In this situation, the professional is looking at the entire portfolio, realizing it’s time to sell some of the holdings that have gains. The high performers either need to be reduced for portfolio balance or have reached their peak. Selling some positions that are in a loss will offset the tax impact of selling the growth positions. And the cash from those sales frees up assets to be redeployed to holdings that might be the next winners.
Consider a strategy that doesn’t involve having individual stocks in your serious investments. But if you have a “play account” with individual stocks, you might want to take your losses early. And don’t take losses personally. Just learn from them.
Linda Leitz is a certified financial planner. She can be reached at email@example.com.