FALSE HOPE

One thing that we at Markowski Investments notice on a regular basis is how many of our clients get emotionally involved with their stocks. When we get an account transferred in from another firm by a new or existing client we give unbiased recommendations on every security held in the portfolio. More often than not many of these investors do not heed our warning when we tell them to liquidate a position. For some unknown reason people will hold on to the losing positions in their portfolio and actually root for them to come back. This false hope, or “rooting for the underdog” mentality, I can appreciate for certain things in life such as athletics; but it can be down right costly when it comes to your investment portfolio.

A survey conducted by the New York Stock Exchange found that one-third of investors never sold any stocks. The death-till-us-part strategy seems brilliant if the portfolio contained nothing but winners. But many of the holdings in the survey were nothing but perennial losers. Terrance Odean, of the University of California at Davis conducted recent research confirming that investors haven’t abandoned this destructive fondness for losing stocks. Odean examined 10,000 portfolios at a discount brokerage firm and found investors were one and one half times more likely to sell winners than losers. Worse yet, the stocks sold on average performed better than the ones they held.

One of the biggest myths that most investors continue to believe in is that nothing is really a loser until they sell it. The fact is that hanging on to a falling stock is more expensive than most investors realize. Imagine that an investor bought 100 shares of stock XYZ in July of 1988 at $30 a share. Let’s say today the stock is at $6.63. The investor may be upset that he lost $2,337 however his real loss is much greater. The opportunity cost that was lost during the time of hanging on to the stock during those “dog” years is great.

Let’s say instead of holding the stock, the investor sold XYZ in 1989 at $20 a share. Because he could take a tax deduction on the $1000 loss, he would be out $600 assuming a 40% tax bracket. If the investor had invested the remaining $2,400 in an S&P 500 index fund; today he would have about $13,000. After paying capital gains tax, and subtracting the price of the initial shares, he would have made $8,400.

The problem is that most investors refuse to admit they have made a mistake. Investors must be psychologically prepared to make and admit mistakes. More importantly, not recognizing a mistake can lead to disaster. Phillip A. Fisher author of Common Stocks and Uncommon Profits states, “More money has probably been lost by investors holding a stock they really did not want, until they could at least come out even than for any other single reason.” Andrew Feinberg of the Individual Investor writes, “Waiting to break even is often a sucker’s game. Consider that a share that has lost 75% would have to rise 300% to break even, or that shares that have plummeted 90% would need to increase 900% to get even.” When we receive a new portfolio at Markowski Investments and are reallocating assets we ask ourselves one simple question. “Knowing what we know today, would we buy the stock today?” Once a sale is completed we do not look back. Being stubborn is not only an unbecoming trait but very costly as well. “When I’m wrong, I change my mind.”