After throwing in the towel on a under-performing stock, you look at it a few weeks later, and it has gone up 30% from when you sold it. How many times has this happened to you? It has happened to me more times that I care to admit. So why do I keep making the same mistake? Why can’t I follow my own advice and “be patient”, ignoring my emotional instincts as well as those of my colleagues and clients? When everyone is telling you to give up and sell, it can be hard to stay the course. I have to remember that as long as the thesis based upon which we bought the stock holds, I should hold the stock and suffer through.
Legendary portfolio manager Tom Russo said that to be a great investor, you have to have the capacity to suffer. No investment is going to be perfect and go straight up every day. In fact, most stocks will go down significantly at some point. When I look back at some of our biggest winners, including Apple, Brookfield Asset Management and the Canadian Banks, they have each dropped 50% or more at one point. Whenever a stock falls that much or does nothing while the stocks around you are going straight up, you must expect to be questioned:
“Shouldn’t we sell now and get back in later when it goes lower?”
“Shouldn’t we sell this loser and buy stock ABC that is going to the moon?”
“That stock has done nothing for me for years, and I hate looking at it in my portfolio. Shouldn’t we sell it?”
As an investor I have to trust my research, not my gut, when making a decision. I have to train myself, my colleagues, and my clients to be patient and trust the process while we wait for value to surface. Too often I have succumbed to my emotions, or the emotions of others, and have sold at the absolute bottom. One of the things we have learned at Baskin Wealth Management over the past few years is how much our behavior is influenced by a large number of cognitive biases that lead us to thinking errors. Among the strongest biases, among all of us, is loss aversion. On average we get twice as much pain from a loss as we get pleasure from a gain. Avoiding that pain becomes a priority that can easily lead to bad portfolio decision making.
To keep me anchored as a portfolio manager, I must be disciplined in my selling process. I should sell a stock when it is clearly overvalued; I should sell a stock when it is clear that my thesis is wrong; I should sell a stock when I’ve found a better risk/reward opportunity. A mistake in investing isn’t just selling a stock at a loss, it is also selling a stock too early and leaving money on the table.
Nobody likes pain and our natural instinct is to avoid it. In portfolio management there is rarely gain without pain. We just have to learn to live with it.
March 5, 2018