Your Investments: Admit your mistake and move on

'One cannot too soon forget his errors and misdemeanors; for to dwell upon them is to add to the offense.'

By AARON KATSMAN
March 4, 2010 04:43
3 minute read.
Aaron Katsman

Aaron Katsman 58. (photo credit: Courtesy)

 
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One cannot too soon forget his errors and misdemeanors; for to dwell upon them is to add to the offense.

– Henry David Thoreau



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With most stock markets off their high levels, many investors have been holding onto losing stock positions for a long time. I recently opened up an account with an investor who then transferred his holdings to me from a well-known brokerage firm. After the transfer was completed, we sat down to review his portfolio.

Some of his stocks were showing large losses. He explained that he had bought some of them a decade ago, at the top of the Internet bubble, and some others he bought about four years ago, a year before the recent market downturn started. He was aware that the stocks were well below the price he paid for them but was waiting to sell them until they got back to his initial purchase price.

I can’t begin to tell you how often I hear that approach taken. Some investors will hang onto a losing position for years in the hope it will return to the original price they paid for it. Unfortunately, this is not a particularly effective investment strategy.



We all make mistakes

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Let’s say you read about a company that sounds like an interesting prospect. After doing some research, you decide to invest in it because it seems like a winner. But when you receive your first statement, you see the stock has dropped. So you decide to follow the policy of being patient. As time goes by the stock keeps dropping. The stock market may be moving up, but you will find yourself stuck with a loser.

In fact, chances are that if the stock starts dropping by 10, 15 or 30 percent, there are problems with the company and it pays to sell. The problem that many of us have, however, is that it is very difficult for us, on a psychological level, to admit that we picked the wrong stock. It’s hard for us to say we made a mistake.



Opportunity cost

It’s important to note that the longer you hold onto the under-performer, the more money it costs. The reason for this is that the investor could have put his funds into something that actually made money. Therefore, stubbornly holding onto a losing stock will only cause the investor financial harm.

In economics, this situation is referred to as opportunity cost. Opportunity cost is defined as the cost of an alternative that must be forgone to pursue a certain action, or the benefits that could be received from taking an alternative action.



Profit from losses

Never think all is lost. Some good can actually be derived from losing stock positions. When the position is sold, the investor realizes the loss, which has certain tax advantages. The loss can be used to offset other gains, thus lowering the tax bill. In fact, for many investors, tax-loss selling may be the most important way to reduce their tax bill. If done correctly (be sure to speak to your accountant before making any trades), it can save the investor money.

For example, if a person has a gain in Stock A and he decides to sell it, he will be taxed on that gain in full. But if he has a loss in Stock B that he actualizes by selling, he can use the amount of the loss and offset it against the gain in A, drastically reducing the taxes he owes. This might not recover the entire loss, but it certainly cushions the blow.

Working with licensed and experienced financial advisers can help you evaluate objectively whether you are holding bad positions. It is also worthwhile working with an accountant to create a tax-efficient portfolio. Many professional investors live by the credo that you should ride your winners and dump your losers. The reason is simple: The stock is probably doing poorly because the company is not performing up to par. This indicates that it is probably a good time for you, the investor, to look elsewhere.



aaron@lighthousecapital.co.il



Aaron Katsman, a licensed financial adviser in Israel and the United States, helps people who open investment accounts in the US.

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