If you’re anything like me, your answer is no. You probably already know that stocks are down 20% and bonds are down 14% year to date.
They will not be reduced considering our loss. But it can make us feel small. And it’s only natural to avoid looking too closely at any evidence that could undermine our belief that we are skilled investors. In a down market, however, making good decisions often requires accepting things about ourselves that we would overlook.
Let’s start by recognizing that inertia can be an option.
According to the Investment Company Institute, since late March, when stocks were within their all-time highs, investors have pulled out nearly $80 billion from stock mutual funds and exchange-traded funds.
US and international stock funds had $19.3 trillion at the end of March. So, even though inflation doesn’t seem to be falling and stocks don’t seem to be rising, investors have only pulled 0.4% of their money out of stock funds.
This is partly because of sheer inertia, partly because millions of people invest on autopilot and partly because changing course when you’re losing money feels too painful.
Almost every investor recognizes the wisdom of the old adage, “Cut your losses and let your profits run.” But the worse thing than losing is to admit that you are a loser.
Therefore, most investors will avoid selling the investment when it goes down. You can pretend that there is no paper damage, or that it will be repaired later. On the other hand, you cannot realize the loss without realizing that you have made a mistake.
Worse, what you just sold could go back, or whatever money you put in could go down—making you feel like an idiot twice.
No wonder it is so hard to sell at a loss and that so many people freeze up in the face of a bear market.
In a recent study, researchers looked at how about 190,000 traders at an international online brokerage used stop-loss orders. These instructions are designed to limit how much you can lose by automatically selling an investment if it falls to a predetermined price.
You can buy a stock at $20 and set a stop-loss order at $15, in theory juggling your loss at 25%. In practice, however, people can tear the cuff: as soon as the stock drops towards $15, they can drop their stop loss to $10. If it keeps falling until it reaches $10, they reduce their stop loss again to $7.50 – and so on.
How common is this kind of behavior? In a recent study, online traders who had already placed stop-loss orders took any action related to their positions, lowering those stop-loss thresholds even further.
The more the prices of their holdings fell, the more the traders fell below which they were automatically forced to sell. Instead of stopping their losses, these traders started chasing them. They intended to quit, but they could not.
Surely professional investors are better at selling?
You are definitely joking.
New research shows that fund managers lose an average of about 0.8 percent returns annually because of poor selling decisions. Managers either sell their most recent winners or losers — who, on average, tend to outperform after the fund is dumped.
“They could have done much better by throwing a dart at their portfolio and selling what they hit instead of the stocks they actually sold,” says Alex Imas, one of the study’s authors and a finance professor at the University of Chicago.
To know whether your selling decisions are sound, you need to track not only the investments you’ve held, but the investments you’ve sold. If what you sold is outperforming what you have, then you are selling the wrong investment – something you will never learn unless you are willing to look.
Making peace with your loss requires planning ahead, says Annie Duke, a cognitive psychologist, former poker champion, and author of the book “Quiet: The Power of Knowing When to Walk Away.”
“Our bias against quitting is really strong,” she says. “When the facts conflict with our feelings, we will find a way to ignore the facts.”
One of the best ways to determine whether you should give up is in advance of what Ms. Duke calls “kill criteria,” which commit you to a set of conditions that an investment must meet. Is – or should be sold.
Let’s say you bought bitcoin last year because you believed it was a protective hedge against inflation. Establishing the kill criterion would have you commit to something along these lines: “If bitcoin goes down when inflation rises, my thesis is disproved, and so should I sell if I’m at least over that period.” I lose 25% when inflation exceeds 5%.”
Other people may have different reasons for owning bitcoins, but you cannot switch the kill criteria after the fact. When your logic turns out to be wrong, you will have to sell, thereby avoiding a nearly 60% drop in bitcoin this year.
For most investors, buying and holding is usually the right decision. But getting rid of your losers doesn’t unite you either.
Disclaimer: This story has been published without modification in text from a wire agency feed.