Why is it important to sell an underperforming investment?
Posted by: Arti Bhargava on Dec 11, 2017, 12.23 PM IST
Clifford, a chartered accountant, has inherited an equity portfolio worth Rs 1.5 crore from his parents. After scanning the portfolio he realises that while some stocks have done very well, others are duds that are bleeding the portfolio.
He is unable to take a call on selling the nonperformers. He is biased towards the shares he holds of what he knows as bluechip companies. He thinks that since they were the right investments at some point of time, they would do well in the long run. Why is it so tough to sell non-performing assets?
How well Clifford does with his portfolio will depend on whether he is able to sell what does not work for him. The crucial skill in managing money is the ability to ensure that it is deployed efficiently. When we refuse to sell what we now know as a wrong investment in the first place, we allow the portfolio to bleed.
Behavioural economists have established that the pain from a loss is disproportionately higher than the pleasure from a profit. He, therefore, might want to readily sell an investment that made him money, but will postpone the decision to sell what is already at a loss. He would justify an investment one way or the other, hold on to it with blind hope, or get bitter about having been fooled into buying the wrong investment, but may not act on it. It is important to review the portfolio and ask if we are holding something that is not good enough to buy now. Perhaps those items need to be sold.
Second, he seems to have invested his emotional capital in the holding decision. Clifford wants to believe that his parents had not made a wrong decision, and indulges in justifying it. The parting is painful! Investment decisions are made based on information available at that time. Subsequent events might alter the attractiveness of the investment. Moreover, Clifford may be sitting on what is losing money in the hope that when the markets turn, all the underperformers will also perform. A downturn could bring about a business environment and business realities.
Investments have to work hard for him to create the wealth that he is looking for. If they are losing money for him, loving them is an emotional mistake.