How can you improve your portfolio?
Photo: Natureworks. Source: Morguefile
One way is to limit your losses. In any portfolio, there will be items that go up and items that go down. We don’t know the future, and in spite of all our research, some investments simply don’t work out. Maybe the economy shifted in an unexpected way; maybe management paid too much for an acquisition. Whatever the reason, something goes wrong and you have a loss. What do you do?
The first thing to do is to understand what’s happening. It’s no good to stubbornly stick to an investment idea when the rationale has changed. Maybe the new story makes sense, but it’s a different story. If you’re investing for growth and your new oil-extraction technology is now a value play, maybe it doesn’t fit your investment objective any more. It’s time to cut it off.
Ironically, one key to managing your losses is to spend more time understanding them, not less. This goes against our nature. We don’t like to be reminded of our mistakes. One of the things good investors do is analyze their errors—why they bought a loser, and why they held onto it. Sometimes, a losing position merits an additional investment—but not usually. Throwing away good money after bad is a combination of the sunk cost fallacy and anchoring. Investors think, “If I average down and the stock comes half-way back, I can get out even.” But the stock doesn’t know—or care—where you own it.
Making investment mistakes is humbling, frustrating, discouraging, and annoying. But it’s an inevitable part of the process. Investors need to learn how to handle failure with grace and respect.
Because if we never make any mistakes, we’re not trying anything new. We learn to walk by falling down. If we never fell down, we’d never get anywhere.
Douglas R. Tengdin, CFA
Chief Investment Officer