Do you want to grow your investment portfolio?
That probably seems like a silly question. I doubt any investor under the age of 70 would answer the question about the desire to grow your investment portfolio with an emphatic, “No!” If you think of the opposite of that question (“Do you want your investment portfolio to get smaller?”) the original question becomes even more sillier.
But what if I told you that in order to grow your investment portfolio, you will quite often be wrong in your decisions. In fact, you need to be okay with having the wrong opinion on a given stock. You need to be okay with it only because you need to figure out what to do AFTER you are wrong.
When a company doesn’t perform the way you want it to perform, you need to cut your losses. Some investment advisers may suggest that you double down on the stock and buy it at a lower cost. That is likely a fools errand. Yes, you will lower your break-even point if the stock rebounds, but what if it doesn’t rebound. What happens if it continues to go down? In order to grow your investment portfolio, you need to cut your losses.
Understanding the stock market is as much of a study of human behavior as it is a mathematical exercise. You need to understand that the herd mentality of the market means that loser stocks tend to continue down until they hit a lower plateau.
In nearly every stock, there is a virtual floor and a virtual ceiling. In most cases, you can assume that the virtual floor and the virtual ceiling is the 52-week high and the 52-week low (this is a generalization). If the stock that you are doubling up on has broken through the floor, you don’t know where the bottom is! You will need to look at inflection points over the last 5 years to know the floor.
So how do you grow your investment portfolio after a drop?
Typically, you will not quickly recover a major drop in the value of a stock by staying with that stock. You will need to cut your losses on that loser stock and invest in another stock that is increasing in value. At any given time (except for massive market corrections) there are stocks that are increasing in value while others are dropping in value. You need to be able to cut your losses to grow your investment portfolio and move to a growing stock.
