Are Your Stocks Losing Value?
All investors seek to invest in the stock markets in the hopes of generating returns on their holdings over a period of time. While you might have done ample research prior to investing your money in certain stocks, it is still possible for you to find yourself in a situation wherein these stocks you hold could begin to lose value. This could be owed to a natural disaster, a pandemic or just sheer bad luck and lack of due diligence with regard to the stock in question. Now, you may wish to sell these holdings but may not be able to decide whether to sell your stocks right now and prevent further losses or hold on to them and sell them a little later when your losses might or might not be larger. The only knowledge you possess at this point in time is the desire to offload these holdings such that you can preserve your capital and reinvest it in a security that is more profitable. If life was tailormade, it would always be possible to fulfil this desire and sell your holdings at the right time.
However, real-life is made up of a series of gambles and is marked by uncertainty. The housing bubble that burst in 2007 exhibits this perfectly. During this time, stocks began to dip, and the bear market began to reign supreme. Investors were uncertain of how to proceed, and several investors didn’t even react right up to the point when their portfolio holdings had slid downwards by 50 to 60 per cent.
Taking a Look at the Breakeven Myth
When investors find themselves in a position wherein their stock holdings are down, they often tell themselves that they will wait for the stocks to rise back to the value at which they originally purchased them for such that they can break even. This line of thinking is similar to that which was followed by several investors in the 2007-2008 financial crisis.
This line of thinking, however, is skewered as there exist a number of factors that point to its flaws. For starters, there is no guarantee that can be provided to ensure that the stock will ever rise again and return to its original valuation. The next flaw in this line of thinking is that by waiting to break even (which is the point at which your profits are the same as your losses), you can seriously eat into your returns. While you might be tempted to go down this path, it is pertinent that you cut your losses.
In order to understand this better, consider the chart provided below that showcases the amount by which a security must rise following a drop just to return to the breakeven point.
|Percent Rise to Break Even
As this table makes clear, in order for a stock that has declined by 50 per cent, it must increase by 100 per cent in order to break even. From a rupee point of view, if a stock drop by 50 per cent from INR 500 to INR 250, it must rise by INR 250 or 100 per cent in order to return to its original INR 500 purchase price. It is easy for several investors to forget the simple mathematics that governs their investments and end up taking on losses that are far greater than they might initially anticipate. They unfortunately are under the misguided impression that if a stock falls by 30 per cent it would simply have to rise by the same percentage in order to break even.
Now, while the above facts are true, there are instances where rebounds do arise. This most often occurs in instances of stocks unfairly plummeting. However, this often involves a time-consuming waiting period that ranges from three to five years which means that the stock eats into money that could be directed towards other stock that could potentially be worth better rewards. As an investor, it is important to always consider future potential rather than clinging to the past as it cannot be altered.
Putting Your Best Foot Forward
In order to successfully traverse the stock markets, it is important to have a predetermined defence strategy in place such that excessive losses can be prevented. The term predetermined is used here as the time prior to or at the time of purchase is the time best suited to thinking rationally about the reasons as to why you seek to sell your holdings. When you have yet to purchase anything, you are unlikely to have any emotional attachment to it and are therefore capable of making a rational decision. However, once you possess something, your emotions such as greed or fear are more likely to get into the way of your making good judgements.