Letting Go

How often have you felt that you can't sell a stock or fund in your portfolio because its value is very depressed, and you keep thinking "I'm gonna wait until it's back at what I paid for it, and THEN I'll sell it and buy something else"? It's almost as though we think that holding owes us an apology for being such a pain.

Here's a little example that may expose the trap you have fallen into. First, suppose that you had logged onto Fandango (the on line movie ticket service) and bought a $10 ticket for a movie that you have been eager to see. You print it out and head to the movie theater. However, on the way from the parking lot at the mega-mall, you somehow lose your ticket. Are you going to be willing to fork over another $10 cash to see the movie? Or do you just turn around and go to Best Buy instead?

On the other hand, if you did not buy your ticket ahead of time, you may have gotten to the movie theater with the intention of paying cash for your ticket. When you get to the ticket seller, you see that there is $10 less in your wallet than you thought (although there is enough money to buy the ticket). Do you still go ahead and buy the ticket?

What is your reaction? A study shows that people are more likely to walk away if they had bought the ticket ahead of time, since they "already spent" the money. But, you have "lost" $10 regardless of the scenario. Due to a behavioral quirk called "mental accounting" you believe that the money already spent on the ticket is more "lost" because you used it to buy something concrete, than the $10 shortfall in your wallet.

In the stock/fund case, you have lost value due to that specific holding, and investors tend to believe that they must regain that loss before they can sell the holding and buy a replacement. However, here is a question to ask yourself: "If I had cash today and was evaluating investments, would I buy XYZ today?" The answer will probably be no. In that case, you should sell that investment and replace it with something better (in these days, sell the GM stock and buy Ford - this is not a recommendation but an example) right now. If you choose wisely you will recover your losses and then some. Don't make the original holding responsible for your investment satisfaction. As Peter Lynch once said "That stock doesn't know that you own it." If that's true, its purpose in life is not to make you happy or to do as you say!