My friend Mark told me recently that he is excited that the recent rally in the market may bring him back to profitability on stocks he wants to sell.
It’s one of the biggest stocks out there, a brand name company that’s been in my portfolio for decades. Mark bought it last fall, enjoyed a gain of about 20% in the first three months he held it, and then saw that gain and more disappear as the stock market crashed in the first half of 2022.
“I’ve waited too long to sell it on the way down,” Mark explained, “but if it can go up just a little bit from here, I’ll get back to profitability and then I’ll give it up. I think I can do better.”
Mark can do better. And it has nothing to do with the specific company, but everything to do with his mindset and the idea that “failure” is some sort of investment objective.
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While no investor wants to lose money, the price at which you purchased a security may be the least important data point an investor can consider while analyzing what to do next.
With the market slumping in the first half of the year and the recent recovery – combined with sticky, high inflation and enough socio-economic concerns around the world to make anyone nervous – many investors are looking at how they can shift and shift their holdings now, whether that means shorting and rebalancing positions or making wholesale swaps of stocks and funds that they will give up as they rotate into positions that better suit their current thinking. This makes this a time when many investors will make mistakes.
Individual investors have a long history of making ill-timed moves, even the easy ones. They tend to buy when something has done well and sell when it cools, meaning they buy high and sell low.
There is a lot of research that shows that investments outperform investors themselves, meaning that people rarely get the best out of the securities they buy; the latest Mind the Gap study from Morningstar Inc. — designed to measure how well investors are doing relative to the mutual funds and ETFs they own — found that bad timing for buying and selling left the average investor behind by roughly 1.7 percentage points a year.
Therefore, you can safely assume that doing less with your portfolio is often more profitable than making more moves and changes. That’s why it’s important not to consider anything extraneous or unimportant in your decisions. Your break-even point is a red herring, something that distracts you from what really matters.
In Mark’s case, once he thought he could “do better” and gave up on the stock, it didn’t make sense to wait for a return to profitability. Besides taking the tax breaks that come with a loss in a taxable account — where the loss can be used to offset other gains — he was holding onto something that, by his own calculations, made him worse off than he would have been after by making the change. Anything to avoid the pain of saying “I suffered a loss”.
Clinical psychologist Stanley Teitelbaum, author of 2021’s Smart Money: A Psychologist’s Guide to Overcoming Self-Defeating Stock Market Investing Patterns, calls it “leveling off.”
“The human instinct is not to take a loss,” Teitelbaum said last week in an interview on “The Money Life with Chuck Jaffe.” “Research shows that it’s two and a half times more painful to accept a loss than to experience the joy of winning a game, so people don’t tend to accept a loss and so they keep losing on paper. … Get-even-itis is a chronic disease in which people delude themselves that they are stuck in a losing situation and cannot take a loss at a reasonable level.
Waiting for profitability to return is a form of bargaining in which people allow themselves to accept something difficult with the feeling that the choice they are making minimizes the trauma.
Ultimately, investors should recognize that stock price is a tool to measure market value, but not by itself a means of fully assessing a company’s value. Prices move for many reasons, and none of them have to do with your original price point, the high point reached while you owned the security, or the trigger point of pain so great that you’ll sell even at a loss.
In Mark’s case, for example, many investors believe that the brand shares he is preparing to sell are more profitable now than when he buys them in 2021, because the decline in price has lowered the price-to-earnings ratio.
Instead of considering whether the stock is a better buy now, trading at 30 times earnings than it was when he bought it for roughly 40 times a year ago, Mark is selling because he’s going back to square one.
Breakeven numbers and highs are interesting points along the way, but they are not real reasons to hold or sell. If the only thing you know about a stock or fund is its price, you don’t have enough information to make an informed decision.
Whatever move or decision you make, there should be a solid rationale behind it. You can sell when things get hot, locking in profits and reinvesting in securities that look undervalued. You might buy when a stock drops like a rock, thinking it’s a bargain.
The more you know about security, the more you can put into your decisions and choose whether to go with the flow or against it. But your break-even point is not a factor. This is not a measure of the investment, but instead simply reflects your time.
Don’t confuse the number stuck in your head with the number that “makes sense.” Manage your portfolio based on your goals, investment objectives, and risk tolerance, and over time, peaks, troughs, and breakevens will take care of themselves.