Pop Quiz

Q. What’s worse than having your diversified portfolio down one quarter or even one third from the tops reached last October?

A. Having your concentrated solo stock position down 75%. 90%. Or more.

You need to read E.S. Browning’s article, “Loyalty Pays a Bitter Dividend,” in the Oct 1, 2008 Wall Street Journal ( page A-1) to survey the wreckage when emotion intersects and collides with personal finance.

Misplaced loyalties will cost you.

The focus of the article was on the profound attachment many investors, especially seniors, have for their long held local hometown bank stock. Or the stock in the mega bank they now own after their local bank was rolled up years ago.

Especially poignant were the stories of seniors who have impaired their financial security by holding on to these fallen angels as financial service companies pay the price for investing in assets they did not fully comprehend or understand.

A recurring theme…”This was the stock that Grandpa (or Dad) acquired many years ago. I just felt a connection and wanted to show respect and continuity by holding on.”

And so we come to the hard truth about wealth management. We tell ourselves that we are objective profit maximizers. But the truth is something else. We allow emotion and sentiment to rule in the one kingdom from which they should forever be banished.

I’m all for continuity and loyalty. For the right reasons.

I will always be the son of my parents, the brother of my siblings, and the father of my children.

I feel grateful and fortunate that my wife and I will celebrate our 30th wedding anniversary next year.

Our stray cat, Ollie, adopted us 10 years ago, and he now has a comfortable home for life. I wouldn’t trade that cat for a new car.

I would never abandon my U.S. citizenship.

But when it comes to financial instruments, loyalty is not part of the equation.

You may fall in love with a stock, but it will never return the favor.

You think you are honoring the spirit of your late ancestor, but my bet is that they are turning over in the grave while you doggedly hold on to a wasting asset. They bought it when it was a shrewd investment…it never would occur to them that you would ride it all the way back down as a filial gesture.

That’s not how smart money acts.

Here are some viable remedies:

1. Don’t get involved in the first place. A company (and by extension, it’s common stock) has a narrative, a history, a story. You can avoid this seduction by investing in no-load funds. They hold 80-100 stocks…too many stories to follow, so you never form the emotional attachment.
2. If you insist on buying stocks, use a trailing stop loss order to take the emotion out of selling. Losing 15% when you are stopped out is a minor insult. Losing 30% of your diversified portfolio is a major hit. Losing 90% of your family heirloom stock is potentially lethal.
3. If you are still convinced the stock will recover, sell and lock in your realized loss, both to offset other gains or carry over to future years income. Wait out your 30 day time period to avoid the “wash loss” rules, and buy it back and ride it back to the top. You may still eventually end up where you started, with unrealized gains, but you already harvested your tax loss to take advantage of the rock bottom price.
4. Try to act rationally, by asking yourself if you would buy the stock today at the current price. You will likely say no, but you don’t want to sell at a loss.
   You must realize that every day you hold a stock, at the current price, is the same as having bought the stock at that current price. The value of the stock can manifest in one of three ways. The current position, the cash from the sale, or the new position after you sell and buy something new.
5. Doing nothing is the same as not doing something else. Opportunity costs abound. If it were not in stocks, it could be in cash, CDs. or used as a down payment for real estate bought at auction.

Learn to continually ask the one and only relevant question about your investments….

So…what have you done for me lately?

Posted: 10|17|08 at 6:38 am. Filed under: mutual funds, stock market.
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