John in Baltimore didn't buy stock expecting to lose money, and he's unwilling to sell his shares at a loss. With more than 1,000 shares invested in a company that he has held through a few nightmarish, volatile years, John has gotten some, but not all, of his money back.
He recognizes the concerns surrounding the company. Having seen the stock mentioned in a recent news article, he wrote: "I don't want to lose all the money I have invested so I hang on. . . . I hope (published concerns) are wrong about the hype running out, at least up till I get most of my money back."
John is far from alone. Ann in Seattle owns a mutual fund that shook her confidence during the 2008 downturn. It's since rebounded reasonably well, but not to her peak holdings.
And while that peak is not the amount she initially invested, Ann considers every dollar below her personal high-water mark in the fund to be a loss. She wants to "at least get back to that point" in terms of profits, so she's sticking with a fund she's unsure of.
Hanging by a thread
Hanging on to a security to get back to break-even is one of the most common mistakes investors make, and at a time when the stock market is completing a yearlong rebound from the bottom of a severe market decline, it's also a dumb idea right now. It's not that a security can't rebound or that purchasing on the dips is a bad idea, but rather that the investor makes the break-even point relevant, when in truth there's no connection.It's not an automatic sell signal, but investors who hang on to a stock simply because it is underwater since the time it was purchased -- or since its market peak, in the case of Ann -- should re-evaluate with an eye toward whether they believe the investment is actually capable of making them whole again.
The typical analysis, however, is about the stock's valuation and where it might go, rather than on the investor's personal numbers. The stock doesn't care that you invested $10,000 expecting some growth; if it loses money and rebounds, it's not to make you feel better about your investment prowess.
Moreover, no one buys a stock or mutual fund hoping simply for break-even. While "don't lose money" is the first goal of most investors, they typically take on riskier investments expecting them to do more than stand still.
'Formula for disaster'
Once that judgment has proved to be wrong, the real question is whether there's any reason to believe the stock or fund is the best bet for recouping their losses, rather than selling the security and finding something else. Waiting for a return to break-even or to a peak number allows emotions -- the upset over a loss -- to overcome real investment strategy.Financial adviser Peg Eddy of Creative Capital Management in San Diego says that "hang on until I'm even" thinking is "a combination of stupidity, stubbornness, ego and inertia. . . . How about that for a formula for disaster?"
The formula is particularly bad because investors like John and Ann aren't hanging on to break even but rather to avoid admitting a mistake.
If they were to sell their investments, they could get the tax benefit from a loss -- offsetting profit they might have on other holdings -- then make a fresh decision on the best way to recoup their losses.
If it turns out to be the same security, they can repurchase it after 30 days and see if they are right; anything less than 30 days would forfeit the tax benefits because the quick round trip would be considered a "wash sale" by the Internal Revenue Service. Eddy noted, however, that while investors fight advice to give up on losers before the break-even point is reached, they are typically so happy to be out of a loser that they never consider rushing back a month later.
Norman Boone of Mosaic Financial Partners in San Francisco recalled a client whose $5,000 investment in a small tech stock turned into a $25 million fortune, thanks to a merger with a big, well-known corporation.
When the market and the stock started to falter, the investor was stuck emotionally on "the full amount" and convinced that the acquiring company's upward trend would continue. The Internet bubble quashed that notion, and the stock lost 95% of its value. Once Boone was able to persuade the investor to protect enough gain to salvage his lifestyle -- and only after the investor was convinced the stock would not "go back up" -- was the stock finally sold.
The investor still had an impressive gain, but it felt like a loss because he had booked every dollar of increase as a profit, making the money "his." Thus, any drop from that "full amount" was a loss.
It's a syndrome that plagues many investors. This week, with the market celebrating the March 9 anniversary of its rebound, many investors will look at securities they are unhappy with and decide to stick it out because a big decline in 2008 was not fully recouped in 2009.
The market and the securities never gave those investors a break-even guarantee. Instead of worrying about getting back to their starting point or high-water mark, investors need to focus on what they think a stock or fund will do next.
Without a reason to expect strong returns -- making it the kind of security you would buy again today given current market conditions -- there's no reason to wait on a security to make you whole. You could wind up waiting forever, holding an investment you stopped believing in long ago.
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