As market volatility rears its ugly head again, here's something to remember on those days when you see a bunch of red on your brokerage screen...
The emotion of losing money greatly overpowers the joy of making money.
We can log into our brokerage accounts and have a dozen stocks that are in the green, some even by double- or triple-digits. Yet, you see a few stocks in the red and that's where all the focus goes. We dwell on the losers, and frustration mounts. But here's something to keep in mind...
Losers are part of the investing game. How you deal with them is what can make or break your portfolio. But don't think you're going to bat a thousand.
Even the greatest investors in the industry suffer losses. For instance, one of the "Oracle of Omaha's" greatest losers was his purchase in 1965 of textile company named Berkshire Hathaway, which he estimated cost him around $200 billion.
You can learn a lot from your losses, arguably more than you can from your winners. However, when it comes to losers, most folks tend to make the same mistakes over and over again. They don't have the discipline to cut them from their portfolio. The human tendency is to wait until the stock gets back to even, so you don't have to sell for a loss. But red stocks don't always go green.
Those losses often swell into even bigger losses, and soon they become a giant black eye in the portfolio. Surely it can't go any lower from here, you tell yourself. And once it does, you find another excuse to just ride it out.
Losses happen. The trick is to control them.
I've shown this table before, but it's worth showing again. Look at what it takes just to recover from a loss...
As you can see, if you suffer a 50% loss you need a 100% return just to get back to even. A 75% loser? Extremely difficult to recover from. We're not talking about making a profit – or celebrating the fact you booked a triple-digit winner -- we are just talking about getting your original investment back. That can be disheartening as triple-digit returns are not exactly a regular occurrence.
Action To Take
It's tough to know the best time to sell, regardless of whether you're looking at a profit or a loss. Nobody knows the exact top or bottom of a stock, or even necessarily the "right" time to sell a stock. But when reviewing the stocks that are trading at a loss in your portfolio – and wondering whether it's time to cut them loose or hold on tight – go back and review why you bought them in the first place.
Is your original buying premise still in place? What is the market seeing that you might be blind to? Keep an open mind and look at from both sides of the equation. Look at the pros and cons of the company and its prospects.
The bottom line is that you must be willing, and disciplined, to cut your losses. As I've said before, bailing on a loser doesn't mean you've failed. It means that you've succeeded... succeeded in avoiding even bigger losses.