Crystallizing losses

I recently read a piece of marketing fluff posing as research from a financial advisor. It recommending holding firm in the face of losses in the stock-market to benefit from the bounce back.

A lot can be learned from how an investor reacts to losses and continuing uncertainty.

One option is to hold tight. All markets have historically turned around so eventually the investment come good.

The other option is to sell and crystallise a loss. Wipe the slate clean and begin again. Remember you may be eligible for a tax deduction on the loss (capital or income).

Thirdly it may be possible to sell part of the investment and holding part. Let’s ignore this for now. Just note you may want to do that.

What are the risks of following either strategy?

The first exposes investors to ruin if the investment collapses and below-average long-term returns if it plays catch up.

The second strategy leads to over-trading. Nobody can time the market perfectly over a long period of time. Transaction costs of entering and exiting investments can be exorbitant.

I am constantly evaluating investment opportunities. My money must work so hard it sweats. Therefore I prefer to cut losers free and allocate the funds elsewhere. This only works if I identify a better investment. If I don’t have an alternative need I ride out the storm.

I do head-miles when I make a bad investment decision (for that matter I do mental gymnastics when a deal goes well). I take pride when I admit my error and get on with life; reminding myself that investing is part of life.

As I make more investment decisions, they become easier. It also gets easier to deal with the inevitable mistakes.

Ask yourself how do you deal with your mistakes. Don’t try to act in a way inconsistent with your values and makeup. Look for what makes you feel physically uncomfortable. Compare crystallising a 10% capital loss followed by a 20% gain to the thought of holding on for a year or two until the poor performer turns around and goes up 8%. This is the same result via different paths.

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