My friend Mark recently told me that he’s excited that the recent market rebound could put him back in profit on a stock he’s considering selling.
It’s one of the biggest stocks out there, a brand name company that’s been in my portfolio for decades. Mark bought it last fall, enjoyed a gain of about 20% for the first three months he held it, and then watched that gain and more disappear as the stock market declined in the first half of 2022.
“I’ve waited too long to sell it on the way down,” explained Mark, “but if it can pick up just a little bit from here I’ll break even again and then I’ll give it up. I think I can do better.”
Mark can do better. And that has nothing to do with the specific company, but everything to do with its thinking and the idea that “break even” is a kind of investment goal.
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While no investor wants to lose money, the price at which you bought a security may be the least important data point an investor can consider when analyzing what to do next.
With the market’s decline in the first half and recent rebound – coupled with persistently high inflation rates and enough socioeconomic concerns around the globe to make anyone nervous – many investors are looking at how they might change their holdings now and see if this means cutting back and rebalancing positions or doing wholesale swaps of stocks and funds that they exit as they rotate into positions that better suit their current thinking. That makes this a time when many investors will make mistakes.
Retail investors have a long history of ill-timed moves, even simple ones. They tend to buy when things are going well and sell when things cool, meaning they buy high and sell low.
There is ample research showing that investments outperform investors themselves, meaning individuals rarely get the most out of the securities they buy. Morningstar Inc.’s latest “Mind the Gap” study — designed to measure how well investors are doing relative to the mutual funds and ETFs they own — found that poor timing when buying and selling drives the average investor by about 1.7 percentage points behind year.
You can therefore rest assured that doing less with your portfolio is often more profitable than making more moves and changes. That’s why it’s important not to include anything trivial or unimportant in your decisions. Your break-even point is a red herring, something that distracts your attention from what’s really important.
In Mark’s case, waiting for a return to break-even after he thought he could “do better” and abandoned the stock was futile. Aside from the tax benefits that come with a loss on a taxable account — where the loss can be used to offset other gains — he was holding on to something that, by his own calculation, left him worse off than what he was after earning it would own the change. Anything to avoid the pain of saying, “I’ve suffered a loss.”
Clinical psychologist Stanley Teitelbaum, author of 2021’s “Smart Money: A Psychologist’s Guide to Overcoming Self-Defeating Patterns in Stock Market Investing,” calls it “get-even-itis.”
“The human instinct is not to take a loss,” Teitelbaum said in an interview with Money Life with Chuck Jaffe last week. “Research studies have shown that losing a game is two and a half times as painful as experiencing the joy of winning a game. Therefore, people are reluctant to accept defeat and therefore continue to make paper losses. … Get-even-itis is a chronic illness in which people delude themselves that they are holding on to a loss situation and that they cannot cope with a loss at a reasonable level.”
Waiting for a return to break-even is a form of negotiation where people allow themselves to accept something difficult because they feel the decision they made will minimize the trauma.
Ultimately, investors need to recognize that stock price is a tool for measuring market value, but not solely a means of fully assessing a company’s value. Prices move for many reasons, and none of them have to do with your original price point, the peak you reached when you owned the security, or the trigger point for pain so great that you’ll even sell at a loss .
In Mark’s case, for example, many investors believe the brand stock he’s looking to sell is a better bargain now than it was when he bought it in 2021 because the price decline has lowered its price-to-earnings multiple.
Instead of contemplating whether the stock is a better buy now, trading at 30 times earnings than when he bought it for about 40 times a year ago, Mark is selling because he will be back where he started.
Break-even numbers and peaks are interesting points along the way, but they’re not really reasons to hold onto or sell. If the only thing you know about a stock or fund is its price, you don’t have enough information to make an informed decision.
Whatever step or decision you make, there should be solid reasons behind it. You could sell when things get hot, lock in profits, and reinvest in securities that appear undervalued. You might buy when a stock falls like a stone, thinking it’s a bargain.
The more you know about safety, the more you can factor into your decisions about whether to go with or against the tide. But your break-even point is not a factor. It’s not a measure of investment, just a reflection of your timing.
Don’t mistake having a number in mind for that number to be “meaningful.” Manage your portfolio based on your goals, investment goals, and risk tolerance, and over time, the ups, downs, and break-even numbers will take care of themselves.