Jordan Tarasoff May 30, 2023 Personal Wealth Should I Sell a Stock at a Loss? “This stock is down. I am going to wait until it goes back up, then I will sell it” This is something we hear often, especially after a year like 2022 in which many companies suffered large drops in the price of their shares. Note there is an important belief in this statement: “until it goes back up”. Will it go back up? How long will it take? What will other investments be doing at the same time? Even if a stock recovers, if it does so more slowly than the alternatives there is a lost opportunity. Oftentimes investors are limited by hard-to-see biases that make it difficult to make a rational decision. How to break through biases To break through these biases, we ask the question: “If the money were in cash today, would you buy the stock?” The reason this question helps is that it reframes the discussion to eliminate cognitive and emotional biases that afflict investors: Action is harder than inaction, selling the stock takes more effort than holding it. If we reframe the decision as a buy/don’t buy, then buying (keeping) the stock takes more effort. Investors overvalue things they own because they own them. Pretending like you don’t own the stock allows you to re-evaluate whether it is a good fit for you long-term. Investors also tend to cling to prior beliefs, even considering new information. Owning the stock felt like a good investment in the past, that is why you own it. New information, a lower price, should be incorporated in your evaluation but it is hard to disagree with your past self. Why selling a stock that is down is difficult Research has shown that losing money hurts about twice as much as making money. Selling a stock that has dropped in value is ‘locking in’ that pain. Once you sell you have lost money but so long as you hold on, there is hope. This is leads to something call the disposition effect: holding investments that are down too long and selling investments that are up too soon. Opportunity cost A dollar in an individual stock is a dollar not in a different investment. If the other investment outperforms the stock while we wait for it to recover, this is a real cost referred to as an opportunity cost. At PWL, we subscribe to a diversified, low-cost investment philosophy. If you also believe that diversified, low-cost investments are the best way to invest then you must believe that a low cost index fund will, on average, outperform stock-picking over the long-term. This is regardless of whether the stock is up or down, a company you have held for a while or one that you just bought. So What’s The Answer? To answer “should I sell a stock at a loss?” we must first identify the biases that may distract us from the core decision. Once we break through these biases we can see the real question is: “does this individual stock holding match with my philosophy, needs and long term goals?”. If the answer is yes, great, continue to hold the stock. If the answer is no, then taking the loss, despite being painful, is the right decision. Share: Facebook Twitter LinkedIn Email CIRO Advisor Report
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