I DON’T WANT TO SELL AT A LOSS

A common worry among investors whose stocks are not performing well is the fear of selling at a loss. Their way of dealing with this situation is to hold onto the losing stock until it moves back to the price for which they originally bought it. At first glance, this doesn’t make much rational sense, but it is a very common scenario. In fact, some investors stick with a losing position for years in the hope that it will return to the original price they paid for it. However, this is usually not the best approach to investing.

We All Make Mistakes

Imagine that an investor buys a stock and it starts dropping by 20, 35 or 50 percent. At the same time he purchases another stock that moves up by 10-15 percent. In such a situation, which one should be sold? All things being equal, most investors should sell the worse performing stock. This is because, even though the stock holder hasn’t yet realized the loss, that loss still exists. Investors need to concentrate on the future, and think about the best way to make money going forward. There is a reason that the stock dropped so much, and it may be highly likely that there are problems with the company. 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 that we made a mistake.

Many professional investors live by the credo that you should ride your winners and dump your losers. The reason is simple. As mentioned above, there is a reason that the stock is performing poorly, which is probably that the company is not executing its business up to its potential. This indicates that it may be better for you, the investor, to avoid putting your hard-earned money there.

Opportunity Cost

The longer that one holds onto an 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 actually 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 in order to pursue a certain action, or the benefits that could be received from taking an alternative action.

Profit from Losses

Never think that 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 then be used to offset other gains, thus lowering the tax bill. In fact, although they may not realize it, 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 and help diversify the portfolio in various ways. 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, 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 whether you are holding bad positions. It would then be worthwhile working with an accountant to create a tax-efficient portfolio.

 

The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.

Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, SIFMA. For more information, visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il