How to make peace with your stock market losses

If you’re like me, your answer is no. You probably already know that stocks are down 20% and bonds 14% since the start of the year.

Looking at our losses will not make them smaller. But it might make us feel smaller. And it’s natural to avoid looking too closely at any evidence that might undermine our belief that we are competent investors. In bear markets, however, making good decisions often requires admitting things about ourselves that we would rather ignore.

Let’s start by recognizing that inertia can be a choice.

Since late March, when stocks were a hair’s breadth from their all-time highs, investors have withdrawn about $80 billion from equity mutual funds and exchange-traded funds, according to the Investment Company Institute. .

US and international equity funds held $19.3 trillion at the end of March. So even though inflation doesn’t seem to be falling and stocks don’t seem to be rising, investors have only withdrawn 0.4% of their money from equity funds.

This is partly because of sheer inertia, partly because millions of people invest on autopilot, and partly because changing course when you lose money is extremely painful.

Almost all investors recognize the wisdom of the old adage, “Cut your losses and let your profits run.” But the only thing worse than losing is having to admit you’re a loser.

Thus, most investors will avoid selling an investment when it is falling. You can pretend that there is no paper loss or it will be solved later. On the other hand, you cannot realize a loss without realizing that you have made a mistake.

Worse still, what you just sold could go up, or whatever you put the money into could go down, making you feel like a double jerk.

No wonder selling at a loss is so difficult and so many people freeze up in the face of a bear market.

In a recent study, researchers looked at how nearly 190,000 traders at an international online brokerage firm used stop-loss orders. These instructions are designed to limit the amount you can lose by automatically selling an investment if it falls below a predetermined price.

You can buy a stock at $20 and set a stop-loss order at $15, theoretically limiting your loss to 25%. In practice, however, people can tear the handcuffs off: when a stock falls towards $15, they can lower their stop loss to, say, $10. If it continues to fall until it approaches $10, they reduce their stop loss again, perhaps to $7.50, and so on.

How common is this type of behavior? In the recent study, 40% of the time online traders who had previously placed stop-loss orders took action related to their positions, it was to lower those stop-loss thresholds even further.

The more the prices of their holdings fell, the more traders lowered the levels at which they would automatically be forced to sell. Instead of stopping their losses, these traders ended up chasing them. They intended to stop, but they couldn’t.

Surely professional investors are better at selling?

You are surely joking.

New research shows that fund managers lose an average of about 0.8 percentage points of return per year due to poor sell decisions. Managers tend to sell either their most recent winners or losers, which, on average, outperform after funds sell off them.

“They could have done a lot better throwing a dart at their portfolio and selling what it hit instead of the shares they actually sold,” says Alex Imas, one of the study’s authors and professor. in finance at the University of Chicago.

To know if your selling decisions are right, you will need to track not only the investments you own, but also those you have sold. If what you’ve sold is performing better than what you’re holding, you’ve sold the wrong investments, which you’ll never learn unless you’re willing to watch.

Making peace with your losses requires planning ahead, says Annie Duke, cognitive psychologist, former poker champion and author of Quit: The Power of Knowing When to Walk Away.

“Our bias against abandonment is really strong,” she says. “When the facts conflict with our feelings, we will find a way to ignore the facts.”

One of the best ways to determine if you should quit smoking is to design what Duke calls “elimination criteria” in advance. This commits you to a set of conditions that an investment must meet or it must be sold.

Let’s say you bought bitcoin last year because you thought it was an inflation hedge. Implementing kill criteria would have committed you to something along the lines of: “If bitcoin goes down when inflation goes up, my thesis is belied, and so I have to sell if I lose at least 25% in a period when the inflation exceeds 5%.

Other people may have different reasons for owning bitcoins, but you can’t change destruction criteria after the fact. When your rationale turned out to be wrong, you should have sold, avoiding much of bitcoin’s nearly 60% drop this year.

For most investors, buying and holding is generally the right decision. But getting rid of your losers doesn’t make one either.

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