There is a rule with investing that you dump your losers. That is easier said than done. Believe me, I have dumped so many losers that have turned around and kept so many that haven’t done anything, I’m not sure what the lesson is, if there is a lesson. But I want to show you why you dump your losers—at least in theory—first. Then we can debate WHEN you are supposed to.
Okay, let’s say you have $10k and you invest it in GoPro. And let’s say that we expect to double our money—across all stocks, not just this particular one—in 5 years. That is pretty aggressive. It is more like 7, but this will keep the math pretty simple. And let’s also say that the growth line is linear, even though we know with compounding gains that it isn’t, which is to say that in this example, your investment goes up $2k/year or 20% to start with a linear trend toward $20k.
Alright. So let’s say that GoPro ain’t doing so hot, and by all accounts that is true. And let’s say it loses 20% that first year, even though it was up and down a lot, but it settled to being worth $8000. Again, just trying to keep the math easy. Conventional wisdom says to dump losers and GoPro just lost your 20% over a year and we are going to call it a loser. Nicely, but it lost.
In order to keep GoPro, we have to be really certain that it can get itself back on track. It now only has 4 years to get to $20k, which means it needs to make $12k over or $3000/year instead of $2000, which is a 50% jump in performance. Every year. For the next 4. On top of an already pretty high expectation. This is why you dump your losers. Again, in theory, with some very blockhead math.
Once you realize this, then you know you need to get that $8000 into something that can earn instead of continuing to throw good money after bad. And believe me, when you sell a stock, even if it looks shitty, it will certainly go right back up. It doesn’t make this a bad decision. It just makes you unlucky.
When Do You Know?
Just like a bad girlfriend, you don’t always know when it was obvious to everyone else. It is hard to separate your emotions and beliefs from your choices. And this is especially true when you first start buying stocks because they represent your choices. As you start to get 20 or 30 of them, then the whole stable reps your trading ability and it becomes easier to be dispassionate about particular positions.
But first make note of the trends. If GoPro did fine all year, and tanked in the last month to end up down 20%, then it isn’t truly a loser. Yet. Make sure that it has demonstrated a penchant to under perform first.
Also, if you can avoid it, don’t buy or sell stocks at key points in their annual cycle. It can give you false premises about your decision.
There aren’t any hard and fast rules about when to dedicate something to be a loser. But do your research. If you think they have an edge on something or have a new product coming out and you want to see it through, then see it through, but set a deadline for where your position needs to be by a certain date and stick to it. It is so easy to talk yourself into not taking a loss, but you have to be strong enough to do it.
In general though, I take a fresh look at my positions after a year and try to divine whether the things that made me interested in buying this stock are still true today. However, you cannot know everything and there is a lot to know when considering the total market forces at play for a specific company in a volatile market.
One Story of a Keeper
I don’t carry many mutual funds, but I have one. It is called Oakmark Funds. It is an international mutual fund. I liked it a long while ago because I wanted to dip a toe into international stuff, but I didn’t know anything. This seemed like a safe path and the fund was reasonable. For a couple years it was a solid earner. Then it hit some wall and tumbled for a couple years. I didn’t have a ton of it and didn’t have anything to replace it with, but I was impressed with their fees and low turnover and just other things that I like with these funds. I paid attention to their shareholder releases—meaning I opened and skimmed them. I was getting all of the signals that the original folks who made it sing were getting back to the helm. So I held it. This particular story has turned out well so far, as it bounced back within a year and has been doing well. But this is an example of riding out the storm. If you have worked for a company for longer than 4-5 years, you have likely seen some ups and downs while you figure things out in your market. If you believe in the leadership, then invest in them.