What to Do When an Investment Goes Bad
Dear Reader,
A for-sure deal, a slam dunker, or as my old broker used to tell me, “Dan, this is a no-brainer.”
These are the types of phrases that are usually expressed before one loses most or all of their capital in an investment.
We often get so excited about the prospects of making money that we forget that with any investment, no matter what it is, there is always some risk.
Even a savings account, which may not nominally change, can be dramatically reduced by inflation.
You just can’t escape the volatility of asset prices. The best you can do is find good value, buying assets when they are cheap.
One of the binds that investors often find themselves in is having trouble selling a bad investment, or even a good investment that has turned into a real loser either due to a bear market or an irrational market.
It was Keynes, an economist I am no fan of, who said, “The markets can stay irrational longer than I can stay solvent.” Who here reading this can relate to that?
Here are 3 Core Disciplines That I Think You Can and Should Apply to All of Your Investments
#1: Trailing Stop Loss
We’ve discussed this many times before. Having a trailing stop loss is something that should be set for all of your publicly-held investments. Even if it’s just a mental one for those lower-volume trades, you have to become disciplined about selling your losers and letting your winners ride. All too often, investors watch a stock fall 90 to 100%.
Everyone knows the feeling. You say to yourself, “Well, as soon as this thing rises back up to a breakeven, I’m selling.” The trouble with this is that stocks tend to rise at a slower rate than when they crash. A 50% decline can happen in a week, but in order to break even, you now need to see a 100% increase in the current price.
Prior to entering an investment, limit your losses by setting up a stop loss. For short-term trades, I use anything from 5 to 15%, and for a longer-term investment, my personal stop losses range from 25 to 33%.
#2: Change Course
Change course. I’ve heard countless stories from investors who would love to jump into real estate, a business, or the stock market, but they can’t until one of their losing investments turns around.
Rick Rule told me that one of the most important lessons you can learn is to not let the bad decisions of the past ruin great decisions you can make today. What this means is don’t be afraid to sell a bad investment idea in order to reallocate the capital to a new idea that you think has more opportunity. You have to forget about those losses and just move on.
When I decided to live a more youthful retirement lifestyle, I had to sell 100% of my speculative investments — many of which were down — in order to buy rental properties that offered up a consistent cash flow to my family’s income.
In 2009, after gold had fallen, I sold some in order to buy more silver. Silver had fallen as well, but at the time, it was a better value than gold.
#3: Ask Yourself This: Would I Buy This Investment Today?
If the answer is no, then sell it.
Let’s say you had $50,000 in a single stock position, and then it dropped to $20,000. If you had $20,000 in the bank, would you use it to buy that stock? If the answer is no, then sell it.
Don’t torture yourself over the money that was lost. You can’t do anything about that, you can only move forward.
The only thing that you should be reflecting on is whether you want to have your capital invested in that stock or somewhere else as of right now.
If the answer is yes, then that’s where you have to force yourself to overcome the emotions and buy.
I remember in 2016, I forced myself to buy mining shares, and it paid off big. That’s a glorious story, of course, one in which many of you reading this made a fortune that year.
But it required patience because I also forced myself to buy mining shares in 2015, only to see some of those investments fall 50% before rising 500 to 1,000% between the fall and summer of 2016.
The ultimate insurance is being extremely selective in the people you partner with. Only back the proven winners, NEVER buy a story, and only buy the management teams who have skin in the game.
An Added Protection
Position sizing is an added protection. Limit individual stocks to 5% of your portfolio. Depending on your age, restrict certain assets to 10, 20, or 30% of your net worth. A stock that is 5% of your portfolio that drops 20% is only a 1% drop for your entire brokerage account.
If your assets are divided up by 4 (25% each) between stocks, real estate, business, and cash, a 50% decline in the stock market is only a drop of 12.5% in your overall net worth. Protecting capital should be your top concern with all of your investments.
Never lose sight of protecting what you already have.
Best Regards,
Daniel Ameduri
President, FutureMoneyTrends.com
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