The Breakeven Fairy Tale (When to Sell Your Losers)

Holding onto your losers forever is a fatal investing mistake. Don’t believe me? Let’s dig into this fairy tale.
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When it’s time to clean-up your portfolio and look at your losers, there are two investing rules most investors should follow religiously:

First rule: never sell your losers because you lose money.

Second rule: never keep your losers because you lose money.

Selling a loser is first and foremost an admittance that you were wrong. Nobody likes being wrong, especially when it means losing money. Denying the problem and keeping your losers forever is a self-destructive way to avoid the cold hard truth.

When we get hit with a 40%+ loss in our portfolio, many of us will be tempted to keep it for a while. I’ll keep my shares until I recover a good part of my losses.

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Bad decision. Holding onto your losers forever is a fatal investing mistake. Don’t believe me? Let’s dig into this fairy tale.

Let’s take a moment to look at what happens when you lose money on an investment. This table will show you how much return you must generate from an investment that suffered a great loss.

Screen Shot 2021-07-26 at 9.52.59 AM

Please note that the more you lose in %, the required rate of return to break even is increasing exponentially. This is how your energy stocks will require you to generate a stock return of roughly 100% for each of them that dropped by 50% only to recover back to your initial investment.

Now, what are the odds you will see your investment bouncing back that strongly in the next 5 years?

That’s correct; it depends on the investment and the situation. But overall, chances aren’t that strong. In many cases, you will hold onto your big losers for several years until you finally throw in the towel and move on.

If you refuse to sell for too long, you may suffer even more. First, you lost your money on a bad investment. Second, you take the risk of losing even more. Tell that to those who kept their shares of Vermilion Energy (VET) after the first drop of 2016. Third, you keep losing money by keeping your dead weight instead of investing your monies in a more profitable stock.

The costs of waiting are insidious. They hurt your portfolio like an infected wound. You must act.

The Oil & Gas fairy tale

A year after seeing the oil price going negative (that’s right, in 2020, you had the opportunity to get paid to buy oil!), this sector is thriving in 2021. Over the past 12 months, we can clearly see a strong uptrend:

Screen Shot 2021-07-26 at 10.04.03 AM

But looking at how strong both oil & gas ETFs surged since the summer of 2020 is giving you false hope. Hence, the breakeven fairy tale. One would believe that with the industry getting close to a triple digit return in 12 months (and many energy stocks more than doubled in price during that period), we would end-up making lots of money over the long haul. Think again, the breakeven fairy tale is really “true”.

Here’s what happens when you extend the same graph to include over 10 years of history:

Screen Shot 2021-07-26 at 10.05.47 AM

This graph includes three oil runs of 2012 to 14, 2017 to 18 and mid 2020 to 2021). The problem isn’t the bull runs, as we had many. The problem is the bear runs that were brutal. Remember that whenever the price of something drops by 35%, it requires a rebound of 54% to breakeven. In the oil & gas industry, we even had 50% drops a few times. This means that each bull run must offer at least a return of 100% to only recover your money.

Then again, if you were able to catch the 2020 bottom when you invested in this sector, you no doubt did great. However, if you invested at the bottom of 2016, you only show returns of 7.64% (BMO) or 5.66% (IShares) for annualized returns of 1.33% and 0.99%, respectively. In both cases, the ETFs have not fully recovered from the 2014 oil bust. That’s a long time to wait to get your money back and this is the kind of trade that would put your retirement plan in jeopardy.

How to make sure it does not happen again

"Know what you own and know why you own it." — Peter Lynch

We all hate losing money on a bad investment, and I know exactly how you feel. Before the March 2020 market crash, I decided to let go of my shares of Lassonde Industries (a Canadian company operating in the beverage business) and I realized a 40% loss on this trade.

I wish I had a magic trick for this dilemma. I would love to give you a way to determine for sure which losers to sell and when to make the trades.

However, I don’t.

Yet, I do have something else that helps a lot. I have relied on this many times in the past and overall, it works very well!

I have confidence.

Investing with conviction means that you invest according to your plan no matter what. You disregard the noise, and you keep moving forward. You know you will face many storms, but in the end, you will reach your retirement goals.

When I wrote my investment process down, I included a part on selling. I’ve highlighted three simple rules for knowing when to sell:

#1 The company no longer meets my investment thesis.

#2 The company cut its dividend although exceptions have been made during COVID-19 (ex: Disney).

#3 The company’s value has appreciated to the point of it being over-weighted in my total portfolio such that I have to re-balance my holdings by selling some of the shares.

When I reviewed my investment thesis about Lassonde early in 2020, I realized I was wrong about the company’s strategy to expand into the U.S. Lassonde faced several headwinds (difficult integration, cost of raw materials and margin reduction) which slowed down its growth and led to a dividend reduction. 2 rules out of 3 were met, so I had to do something.

I sold my shares right after reviewing my investment thesis and quickly reinvested that money in another company from my buy list (VF Corporation (VFC)).

It’s too soon to tell what will happen with this specific trade. However, when I look at my total portfolio, I feel good about being up double-digits so far this year. My investment process is solid enough to allow me to absorb a few losses from time to time without suffering major damage to the total portfolio.

Cheers,

Mike Heroux, Passionate Investor & founder of Dividend Stocks Rock

P.S. Are you concerned by the current state of the market? Download my free DSR Recession-Proof workbook and make sure you don’t suffer during the next market crash.

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**Please do your own due-diligence before investing in any stocks we discuss in this article**

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