What should you do if you made a bad investment? Should you hold onto stocks that aren’t doing well in case they improve, or should you sell them before you lose more money?
The answer to this question, which most investors face during their investment career, can be found in chess.
When you play chess, you may find that the best way out of a bad situation is to get rid of a useless piece that isn’t helping your position. Similarly, investors must also consider when to let go of a bad investment. An underperforming position can often wreak havoc on your overall situation, so try to dispose of it as soon as possible.
Don’t wait for a magical solution
Though you must expect volatility in the stock market, when fundamental changes occur in a company, don’t wait around for a magical solution. Follow the wisdom of the Steve Miller Band: “Take the money and run.” Don’t spend weeks mulling over a decision to sell a stock. If the original reasons for owning it no longer apply, get out even if it means you will lose money.
Cutting your losses now may avert an even greater potential loss in the future. For example, when Washington Mutual, Inc., which used to be America’s largest savings and loan association, lost its high investment rating on September 15, 2008, some of its investors sold out immediately and got some of their money out. But those who waited ten days woke up to the headline that the U.S. government seized the Washington Mutual Bank and placed it into the receivership of the Federal Deposit Insurance Corporation (FDIC). It was the largest bank failure in American history in terms of assets under management.
How do you know?
With FDIC backing, depositors in the bank had almost no risk and did not lose anything. Shareholders, however, had no government backstop to protect them. Many companies have suffered a similar fate, from airlines to banks, car manufacturers to energy companies, and the list could go on. In most cases, there were some indications of fundamental changes in the firms. But it’s impossible to spot all of the developments and make correct decisions every time about whether to sell a stock. However, if you want to own a portfolio of equities, you need to watch them on a very regular basis, not just once a month.
Determine if short-term issues like earnings reports or bad weather caused the changes in a stock’s price. If so, you may want to ride through the instability, or if more serious problems have arisen in the company/industry, you might want to sell what has turned into a bad investment.
To learn other strategies in dealing with bad investments and other tactics to build your wealth, read Rich As A King.
Douglas Goldstein, co-author of Rich As A King: How the Wisdom of Chess Can Make You A Grandmaster of Investing, is an avid chess fan, international investment advisor and Certified Financial Planner (CFP®).
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