I got a lot of great responses to my “I just lost a lot of money in investments” post via reblogs and email. (Short version: I have some savings in various stocks and mutual funds I bought last year that I’ve now lost about 30% on, and I was considering selling them.)
One sentiment I keep hearing is that I shouldn’t sell stocks now, because then I’ll be confirming and setting my loss — that I haven’t actually lost money until I sell, and I should instead hold everything and wait for it to go back up.
This is a very commonly held misconception. It’s flawed economically, and it sounds like a gambler’s rationale.
I bought some Apple stock at about $150. It’s now down to about $95. Regardless of whether I sell or hold, I’ve now lost money. My investments are worth less than they were when I bought them. That’s losing money.
One of Jim Cramer’s most valuable lessons is to ignore your cost basis (how much you paid for your stocks) when deciding whether to sell, hold, or buy more of a stock. It doesn’t matter how much you paid for it — what matters is where it’s going now. Sell if you think it’s going down. Buy if you think it’s going up.
Most people can’t ignore their cost basis because it goes against their emotional nature. You don’t want to sell a falling stock because you don’t want to admit that you made a wrong decision, or you don’t want to admit and realize a loss, or you assume it will just bounce back up and you’ll be fine.
But these stocks are way down. The money’s lost already. I made a wrong decision, and I realized that loss, and it’s probably not going back up anytime soon. My biggest mistake has been continuing to ride the stocks down, even though I felt that
The root of much of this flawed thinking is that people seem to think a sale is final — that once you sell, you’ll never buy that stock again, and your loss will be permanent. But buying and selling stocks and mutual fund shares is easy. It’s 2008. You don’t have to send a telegram to your high-priced broker with huge trade minimums and hope there’s a good market rate whenever he executes the trade. I can trade relatively small amounts of money for $13 at E-Trade in seconds. Deciding what to do takes much longer than actually doing it.
(This applies more to stocks than mutual funds. Most mutual funds take a day to respond and have trade limits and higher minimums, but it’s still nothing like the way it was before online trading.)
If you’re reasonably sure that an investment is likely to go down, sell it now and let it fall, then buy it back when you think it’s likely to go up.
If I had sold 30 shares of Apple when it was at $150 and falling, I’d be sitting on about $4500 in cash. It has now dropped to $90. I could have reinvested that $4500 now if I felt it was going to go up again, and I would own 50 shares instead of 30. If the price recovers and it climbs to $150 again, my investment would be worth $7500. But if I hadn’t sold and I just let it fall with my money invested in it, the best I can hope for is that it goes back to $150 and I get to recover my original $4500. And there’s no guarantee that it will ever go back up.
That’s the trick: let it fall without being invested in it. Obviously you can’t guarantee that you’ll time this properly, but the risk isn’t so bad here if you pay attention. You don’t have to sell at the exact top and buy at the exact bottom. You can wait until there’s a significant upswing happening before buying back in with reasonable confidence.
I believe that many stocks are still likely to fall further, so I decided to sell some of mine. If I’m wrong and this is truly the bottom, I’ll just buy back in when they’re a little higher and miss out on some of the recovery — and that’s the worst case. That’s not so bad. I’ll just have a smaller gain than someone who timed it perfectly.
But if I’m right, and stocks fall further, I’ll have saved a lot of my money from being lost by selling them now and waiting until an upswing to reinvest that money.
Sidenote: I bought a small amount of NVIDIA for around $25/share. It wasn’t doing very well and I feared that their sales and roadmap were weak, so I reluctantly ate the loss and sold it for about $21 in June. That ended up being a very good move: riding it out would have been a bad idea.