One of the costliest mistakes that investors make is holding on to bad investments too long. This is one of the most difficult mistakes to avoid, or at least limit, because it is so tied up in emotion.
When you avoid selling a bad investment, you’re avoiding the pain of admitting a mistake.
Humans like wins. But even more so, they don’t like pain. They will limit their winning (by holding on to bad stocks too long) to avoid pain. I know I have made this mistake before, and I am probably making it right now. It’s a bad habit that I want to break or at least limit to the largest extent possible.
When I was reading chapter 4 of Peter Lynch’s Beating The Street tonight, his thoughts about being an offensive investor and not a defensive investor connected with me and relate to the mistake of holding on to a loser too long. Lynch’s way of framing things as being offensive and defensive was a new spin on this topic that I had not heard before, and I like the way he frames things with this athletic language.
Lynch writes, “Rather than being constantly on the defensive, buying stocks and then thinking of new excuses for holding on to them if they weren’t doing well (a great deal of energy on Wall Street is still devoted to the art of concocting excuses), I tried to stay on the offensive, searching for better opportunities in companies that were more undervalued than the ones I’d chosen.”
So there it is, a great way of framing this mistake that many investors make, the holding on too long to bad investments. Instead of being defensive and coming up with excuses and rationalizations for holding a stock that you made a mistake on, be offensive and constantly look for better, more undervalued opportunities and move on to the new investments fast, once you’ve realized you made a mistake.
Of course selling an investment for cash is also a good idea when you’ve made a purchase mistake, but by being offensive and constantly looking for new, better opportunities, it makes it more likely that one will indeed find something new that they like better and sell their mistake as quickly as possible. Stay on the offensive like Peter Lynch!