I heard a great quote yesterday:
“Stock investing is like a roller coaster. You don’t get hurt unless you jump off.”
This quote is in line with the popular bromide which is the title of this post. It is certainly true that most people lose money — and don’t regain it — when they decide to sell everything because the market has dropped. If you find yourself inclined to sell everything when your account balance falls a bit, you are clearly not suited for the ups-and-downs of stock investing. People who make money are those who are willing to stay in the market thorough the various drops. Those who are really successful use big declines as a way to buy stocks at a discount. I made far more money in the year following the 2008 decline than I made in the previous four years by picking up great stocks like Aflac and Home Depot at a steep discount that had fallen along with the market.
The idea of “paper losses,” and that you don’t actually lose money until you sell, however, is a false one. The value of your shares is whatever the value of your shares happen to be at the current time. Just because you paid $20 per share doesn’t mean you have not lost money when the stock price drops to $10 per share.
People in houses who paid $500,000 during the bubble don’t feel the value of their house is still $500,000 if comparable houses around them are now selling for $300,000. In fact they feel that they were somehow cheated when they took out the loan and should not be obligated to continue making payments. Somehow the value of stocks is temporary in people’s psyches but the value of houses is permanent.
Does this mean that one should sell a stock when it declines in price and take the loss? No, certainly not. But one should also not hold onto a stock that has gone down in price just to avoid taking a loss. The stock is worth what it is worth. Just because you paid more for it does not mean that it will return to that price anytime soon. Even if it does return to that price after a long period and you are able to sell without taking a loss, you have lost the time value of the money invested. You could have invested in something else that went up while the dog you held sat there.
So what’s my point here? The point is that you should approach each stock as an investment today. Given the relative value of the stock to current and future earnings, would you buy today or would you buy something else? If the answer is “yes,” you should hold onto the stock. If the answer is “no,” sell and put the money somewhere more productive.
Note that a decline in price by itself is not a reason to sell a stock, nor should you only look at stocks in your portfolio that have gone down for possible sales. Remember that you are buying companies. The price offered by the market at any given time is just that – the price people are willing to pay for the shares right now. If the company shows a lot of promise, you should hold even if the price drops. Likewise, if the company is running out of room to grow and earnings are beginning to flag, you should consider selling even if the price has increased.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.