Warren Buffett claims to have only two investment rules.
- Don’t lose money
- Pay attention to rule one
These are useful, but not practical in the sense that if you risk nothing, you stand to gain nothing. Everything includes some risk. Investing involves risk and that means sometimes you will lose. I am certain Warren has many more rules, some intuitive.
What should happen when Investment losses appear?
Reevaluate your position. Has something happened that was not in your original assessment? Some losses are not permanent, merely a pricing issue. If nothing has changed your original assessment of value, then maybe you are sane and all others are not. Knowing how markets price assets is an important skill.
There is a relatively easy way to think about it. Would you buy the security at the price it presents today? If no, then you should not keep it either. All purchases are a decision between the money and the security. The elements are the same in the keep decision, only the order is different. Money becomes stock or stock becomes money. Either way you would have the stock only because you prefer it to the money.
The same rules apply to stocks that have gone up. If you would not buy it at the price, you should not keep it. There may be some tax implications that would change that and they should be assessed. Money or stock? It is always the same.
The “Hold” category that analysts supply is a little mysterious when you think about it. It really says, that the facts are such that no decision is a best guess. Like psych testing where you decide on a 1 to 5 scale, all of the 3 answers get tossed. They mean nothing. Hold is a cop out.
Ira Gluskin is a founder of Gluskin Sheff and Associates, a very successful money management firm in Toronto. He has explained very clearly what happens when you fail to assess your portfolio objectively.
“If you get rid of all your winners by taking small profits and keep all your losers in hope of recouping your losses, you will end up owning every dog that has ever hit the floor of the stock exchange.”
That is a sturdy rule.
Knowing how to assess value is important and when coupled with a knowledge of how markets assess value and set prices, you can minimize the effect of the emotions in your financial decisions.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: firstname.lastname@example.org