A recurring dilemma for anyone investing in the stock market, whether directly or via unit/investment trusts, is what to do with poor performers.
Even the most successful investors suffer from “dogs” at one time or another – the shares or funds that have not lived up to expectations and constantly bark at us for a decision: grit our teeth and hang on? Or cut our losses and sell? Over the years I too have accumulated mangy specimens – so many at times I could open a large, cacophonous kennel, with specimens ranging from the whimpering poodle to the barking mad.
The conventional wisdom is that private investors should take the loss and re-invest the money elsewhere – somewhere with a better prospect of recouping your capital. But it is not so easy. A decision to cut losses is an admission of defeat, a recognition that our judgement was flawed. This is never easy to accept.
Second, it flies in the face of advice to avoid selling out at, or near, the bottom. Third, it turns a blind eye to prospects of recovery. A share or a fund may be hit by a temporary, or “one-off” event or adverse circumstance while the underlying case for investment has not been seriously impaired.
And finally there is the powerful pull of inertia. Most private investors do not trade frenetically on a daily basis. Most are buy-and-hold investors with loyalty to the company or fund.
So I had every sympathy with the blog on the Citywire website where the writer wrestled with this issue. Over the years he had found himself selling his successful investments but clinging on to his dogs. His is a club with a very large membership.
To deal with this dilemma he developed a strategy – or more accurately, predisposition – to consider selling when the price rise of his share or fund is equivalent to five years’ worth of current income. While sensible enough, it can be fiddly to work out and I am always suspicious of making decisions solely on statistical formulae. And, like the Citywire writer, I would be reluctant to sell a share or fund where the yield is still attractive and the likelihood is the dividend level will be maintained.
It is a good discipline when buying a share or investment fund to make a note of reasons why the purchase was made. This can be revisited when a loss does occur and the position reviewed against the initial buying criteria. If these have been violated, sell.
The other piece of advice, for the brave, is to take advantage of a fall in the share price to average down the initial purchase cost by buying some more. This is by no means an approach to be adopted on all occasions, only on those where the downturn looks to be temporary or where the management has clearly and credibly set out where there has been a temporary setback. But we must face the truth: some dogs will need to be put down for our own financial sanity.