Investing Psychology: Taking a loss

One problem that I and most likely every other investor has come across is being faced with a loss on a particular stock, bond, or mutual fund. No one likes to take a loss on their investments and it is a tough pill to swallow. I sometimes find it hard to stick to my guns and dump the losers so I can invest in potential winners.

Just yesterday I finally sold a couple of my loser stocks. I decided back when I bought them on the time frame and amount of gain I expected from it. The problem is this gain did not materialize and in fact became a significant (50%) loss on the investment. Fortunately for me it only totaled $350 originally invested so it is not the end of the world. I still found it hard to sell even though I assured myself I would no matter what.

Today I was thinking about why it was so hard for me (mentally) to sell them. For a while I kept telling myself "it will come back up" and "the market is just in a tough spot now." I actually delayed selling beyond my planned time as a result. I now know why I did it:

1. Selling for a loss is like admitting defeat. It feels like you surrendered.
2. Selling for a loss means you were wrong. This is not always true but we seldom enjoy making wrong choices.
3. I do not like making bad investment choices. In my case I spend a lot of time working and researching for my investments and do not like making bad decisions.
4. The economy is down. This is a fact and I know some of the loss is the result of this. My downfall was blaming the entire loss on it.

I also need to note that these investments were individual stocks. I bought them because I thought they were undervalued and the market proved me wrong. I have a small portion of my portfolio that I use as "play money" to invest as I choose. I have always loved finance as a hobby and like to dabble in the market a little. I do this partly as a learning tool and partly for the potential returns and the fun of it.

The psychological aspect of this experience can also be applied to "normal" diversified mutual fund investments. If you need to sell off some investments to pay for a large unexpected expense or even in retirement for income it is important to sell it correctly. If you sell from other investments and not ones that happen to be down you can throw your portfolio even further out of balance and actually increase risk or exposure to a certain asset class.

The moral of the story here is to have a set investment plan and stick to it. Re-balancing once per year is absolutely necessary in order to stay on track and not get too heavily into one investment. It forces you to sell winners while they are high and buy others while they are "on sale." If you do choose to invest in individual stocks or "play the market" a little you must have your "acceptable" loss and gain amounts and stick to them. Getting greedy or procrastinating can wreck havoc on your financial health!