Losses are part of any investor’s journey to be financially independent. It is not pleasant but we have to learn to manage them if we want to be more successful in investing. Today, I will be discussing on a few points to consider when your stock (or counter) registers an unrealized loss in your portfolio.
1. Re-evaluate your risk appetite
I know I have mentioned this in my previous post Investing: A Step-by-Step Trading Plan but if you find yourself constantly selling your stock at the slightest drop in share price, you might want to reduce or avoid exposure to the asset class you purchased previously. Perhaps you are over-confident on your ability to take risks. Maybe you may want to buy a less riskier asset class like bonds or money market funds instead? There are also risks involved in owning such assets but they are not as volatile as REITs or stock.
2. Check the company’s fundamentals
If risk appetite is not the issue you face, maybe you may want to double check if the company you are vested in is profitable over the past few years. If you invested your money in a company without checking its financials properly, you may want to use this as a learning opportunity to not buy stock on impulse or on a hot tip given by your friends or broker. You may sell the stock to cut your losses if you realize that the business is on a financial loss over the long term.
3. Check the company’s valuation
If the stock you own is highly profitable over the years but you still suffered a financial loss, you may want to check the company’s valuation which you paid for prior to the drop in share price. Are you paying too much for the stock? Is the price you paid for near the 52-week high before it falls? If the company is still profitable, you may want to see this as an undervalued opportunity to accumulate more shares.
4. Check the overall current market condition
If the company you bought is not overvalued, you may want to check the investors’ sentiment in the broader market like the STI or S&P 500. If there is a bearish sentiment among investors (meaning the index drops by 10% or more), you may want to use this as a bargain buy opportunity to purchase cheap and undervalued stocks. What if the stock price falls even though the market is still bullish? We go to the next point..
4. If the price drops by more than 30%, you may consider cutting your losses
If you are unfortunate enough to have a counter that drops by 30% or more (and the market is not overly bearish), you may want to sell it to cut your losses. Why is that so? Because to recover from the fall in price, your stock has to rise by about 143% (almost 1.5 times). If you estimate that this could take more than 5 years, it would have been better to accept the loss and put the remaining money into other more potentially profitable investments. As there is an opportunity cost to waiting your stock to go up in value. If you are more risk-averse, you could set your selling price to be no more than 80% of purchase price. You would then only require the counter to rise by 1.25 times should you experience that loss.
For more detailed resources on how to manage your losses, you can check out the following article at The Motley Fool: