People in general like to buy stocks and other investments; very few love to sell, especially when their investments are down in price. Investors often rationalize that as long they hold an investment, they still have hope that it might come back up at least enough to get out even. Once you sell, you abandon all hope and accept the cold reality of the financial loss. Investors often hope rather than being realistic. However, you just cannot afford to have a love affair with any investment. Welcome to the world of risk.
Let’s see where the real problem lies. Does the fact that you want a stock to go up so you can at least get out even have anything to do with the action of the stock market? The stock market has no interest in your wishes, so the answer is no. Try to overcome this harmful emotion because it has absolutely nothing to do with the action of your stocks. Investors are often irrational. While we all have a tendency to believe that we are making good sound decisions, we occasionally stray from a preferred plan of action because of fear, anxiety, impatience or other reasons. Arrogance, stubbornness and complacency can be lethal in the business of investing.
Advisors and brokers should always prepare their clients for the worst that might happen when they recommend and investment. No one in the market, professional or otherwise, can hit all of the time. In fact many pros will tell you that if you cut your losses short and make good on just over 50 percent of your investments you can do pretty well. By planning for the things that can go wrong, you are automatically setting up your psychological make-up for the possibility that the investment you are making might be a bad one. This is a good starting point.
Always ask questions before investing. Why are you doing it? Are you putting money into the market to prepare for retirement, to have a little fun or make up for a shortfall in other income? If you do not know the answers, or choose to get involved for the wrong reasons, there is a good chance that you will suffer substantial losses. The next question you should think about is: What happens if things go wrong? By realizing that you might be wrong in your investment choice allows you to make plans for what to do in case things don’t go well. Recognizing that you could be making a bad investment is the hallmark of good investing.
Most importantly be on the lookout for denial. If you find that you not opening your investment statements, only viewing your losses as paper losses, not talking with your financial advisor or hoping that the market will make it all right, you are probably in trouble. It’s most likely the time to cut your losses and get out of the investment. Rationalization is very powerful and can cause you to freeze, making it near impossible to take action. If you take no action, you will most likely experience even more losses.
The average investor will not take the time to study and analyze what they are doing right and what does not work. However, this is how you will get better and develop good investment habits. Personal opinions, ego, the avoidance of embarrassment and the need to be right have no place in one’s investment strategy.
Famed investor Jessie Livermore opined, “Profits always take care of themselves, but losses never do. The speculator has to insure himself against considerable losses by taking the first small loss. In doing so he keeps his account in order, so that at some future time, when he has a constructive idea, he will be in a position to go into another deal, taking on the same amount of stock as he had when he was wrong.”
Bernard Baruch known as “Wall Street’s elder statesman” had 10 rules. Rule number five is, “Learn how to take your losses quickly and cleanly. Don’t expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.”
Finally, there are two major emotions in the market—hope and fear. The only problem is we hope when we should fear and we fear when we should hope.
Quote of the Week: “I’ve never been poor, only broke. Being poor is a frame of mind. Being broke is only a temporary situation.”—Mike Todd, 1958
Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.