“You don’t have to make money back the same way you lost it. A stock doesn’t know you own it.” – Warren Buffett from Berkshire Hathaway’s 1995 Shareholder Letter.
You’ve heard it over and over again, “Don’t get emotionally attached to an investment.” Yet, it’s easy to get attached to a particular investment, especially if you personally like the company or feel you were clever in originally selecting the stock and don’t want to admit you may have been wrong. However, when it comes to investing and building wealth, you need to remove emotional attachment from the equation as much as possible.
Remember that money is a tool and so are investments. If the fundamental story has changed (i.e. the tool no longer serves its purpose), don’t be afraid to pick up a new tool and seek better opportunities. Buffett would say this does not mean you should be actively trading and moving in and out of positions at the first sign of trouble. Rather you must do your due diligence on the front end before originally selecting a stock and look to build in a margin of safety to minimize potential losses if you do decide to sell. A margin of safety is simply buying a security at a price significantly below what you believe to be its intrinsic value. Prudent due diligence on the front end helps you determine whether a particular price is attractive.
Rather than cutting their losses and moving on, many investors choose to hold and say that they’ll sell when the price gets back to $XYZ level. These investors are similar to players in a casino who keep doubling down on the same losing game, hoping their luck will change. Remember that hope is not a viable investment strategy. Say you invested $10,000 on a stock that is now worth $5,000. If that $5,000 was fresh capital to invest, would you use it to purchase that same stock, or do you see better opportunities for that money? The stock market consistently provides mis-priced opportunities if you’re vigilant, so there are likely assets with better upside and priced at a level to provide you with a nice margin of safety. That’s the analysis you should be doing when trying to determine whether to hold or sell, i.e. the potential Opportunity Cost of holding versus selling. In this example, your investment has decreased by 50%. People often don’t realize in this situation that in order for your investment to break even, it needs to rise 100% from where it sits today. You should strive to limit the influence of money you’ve already spent (i.e. the Sunk Cost) on your decisions about what to do next. This is a difficult psychological bias to break.
Encapsulating these ideas in his unique way, Warren Buffett also states, “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
NOTE: This post is not a commentary on specific investing strategies, particular securities, active vs. passive investing, etc. That’s not the purpose or intent of this website. Rather, this post is a commentary on the principles of opportunity cost and sunk cost.
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