Why does my portfolio always look red?

The market correction in recent days has demoralised many investors. Some may not even want to look at their portfolios at all.

First up, let’s talk about:

Two types of Investors who’ll find it stock investing difficult

One group of investors don’t bother to invest long term knowingly, because they think it is too slow. The second group think that they are investing long term but they are actually not. I’ll label the former group “Knowingly” and the second group “Unknowingly”.

1) The “Knowingly” Investor

The instant gratification world and constant money race have caused many investors to focus short term. Some went into the stock market in a bid to change their lives or solve their money problems. This is a dangerous notion because it leads to risk-taking behaviour that often results in losses, deepening their money woes.

That’s why one of the prudent investing mantra is to ‘only invest money you don’t need in the short term’.

But the stories of a few people getting rich quick are too good to be missed. It creates the Bannister Effect where they believe they can do it too, conflating luck with skill.

The thing is that there are more unlucky investors than lucky investors, but the unlucky ones do not make it to the news. Relying on luck alone offers poor odds.

“Why invest long term when you can make loads of money short term?”

The thing is that what goes up fast in a short time, collapses quickly too. And it is almost impossible to know when something would collapse beforehand, but the “Knowingly” group believes they can time it.

Sometimes, it could be a temporal dip in prices due to volatility and prices rebound quickly. Witness it a few times and the “Knowingly” group thinks that good times will last, until it doesn’t.

When the crash gets too deep or the drawdown becomes protracted, the loss becomes too painful and the wait too long. The “Knowingly” group gives up. They will leave the stock market and find another way to get rich quick.

2) The “Unknowingly” Investor

This group thinks that they are investing “long term” but their thinking and behaviour say otherwise. For example, they will hop onto the hottest stocks at the moment, especially those with share prices that have done well recently.

They simply extrapolate the recent good results into the future instead of thinking critically about whether the growth is sustainable or identify the threats that would hinder such growth. Instead of looking for disconfirming evidence, they succumb to confirmation bias, looking for positive signs to justify their investments. They may also suffer from FOMO and would just buy at any price, disregarding valuation.

Although they tell themselves they are long-term investors, they check stock prices regularly and harbour the expectation that their investments are going to worth more next week and next month. They feel happy when the value goes up and sad when the prices go down.

When their investments drop 50%, they tell themselves they are still long-term investors but the feeling is different – deep down inside they felt regretful. They expect to hold onto profits long term, not hold onto losses long term.

Long-term thinking is extremely hard in today’s instant gratification world. Everyone else are showing his or her successes but not struggles. It is easy to get frustrated with the lack of progress and you want to accelerate your success.

The stock market doesn’t allow you to rush success. It decides where it wants to go. Your expectation is not going to change the stock market, it is easier to change your expectation.

So, why your portfolio always look red? Regardless of the type of investor you are, this is due to the disposition effect – investors tend to sell winners and keep losers.

The Disposition Effect

Think about this.

A stock has gone up 10% in a few days, there is a tendency to want to take profits in case the profits ‘disappear’. The mind might be thinking “10% in a few days instead of waiting for a year, sell now!”

Or it could be another scenario where the stock has gone up 10%, then drop back to the buy price, and subsequently go up another 10%. The tendency to take profits is even higher because profits have disappeared before and you don’t want to let it happen again.

A major correction makes things worse. Investors are likely to sell stocks that are profitable while keeping those in deep losses. The fear of locking in whatever profits left is immense while confronting the deep losses is too painful. So they take profits quickly.

When it comes to a 5% loss, investors will think that it is just a small drawdown and it is normal to experience some volatility in the market. “This is not scary”.

When the loss becomes 20%, investors will start to wonder what’s happening but would still hold on to the investments because selling means realising the loss. Not selling means there’s a chance that the share price might rebound.

When the loss becomes 50%, they resigned to be “long term investors”. What it really means is that they expect to wait for a long time for the share price to rebound.

When the loss becomes 90%, they have mentally given up on the stocks. But they will still hold and give a reason that it is not worthwhile to sell at all. The inaction is likely due to the pain of confirming the huge loss.

If all the winners are sold and the losers are kept, it doesn’t take a genius to know that the portfolio will look red all the time.

How to avoid a red portfolio?

The solution is not to make selling decisions based on gains and losses. If you are a fundamental investor, you should be focusing on the underlying business. If the business has deteriorated and you know it has become a wrong choice, you should sell it even if it is a 50% loss.

This is also true even if you are a trader focusing on price movements. You are suppose to cut loss when it is time to cut and not hold on and allow the loss to grow bigger.

There is a lot of pain now as the US market is dropping like a rock with each passing day and it is not easy to think straight. Some investors are at a loss, wondering if should they sell or hold. There is a high chance that even a red portfolio can have stocks that are worth keeping and stocks that are deserved to be rid of.

Remember some stocks will never go back to your buy price, even in the long term. These companies generally do not have the fundamentals to perform or even survive given enough time. So, you should identify and sell them early. Not keep them because of the fear of confirming big losses and harbouring the hope that you can sell for a breakeven.

Money is fungible. You don’t need to make money back the same way you lose it. You can sell a losing stock, move the capital to another stock and make profits. Such times will test your honesty with yourself.