Cut Losses

“It’s not the ones that you sell that keep going up that matters. It’s the ones you don’t sell that keep going down that does.”

–Warren Buffett

Investment Wizards like everyone else sometimes make bad investments—the key however is avoiding the big losses – the ones you may never recover from. Wizards are ALWAYS eager to cut losses. It is okay to forego opportunities but NEVER okay to suffer permanent capital loss. Cheap markets can get cheaper, and expensive ones can get dearer. While it may seem obvious that you do not want to lose money, why is it critical never to have large losses? Here’s why:

The higher the percentage loss, the more you will need to generate in gains to return to your original level. At 5% loss, you will only need 5.3% to recoup. At 20%, it takes 25%. To lose 50%, one must regain 100%, and if down 90%, a whopping 900% is needed to recoup. It becomes exponentially harder to get back into the game the more you lose.  

Just as our Seventh Commandment  (C7: “Marathon the Winners”) advises to keep the winners, the Wizards advise to get rid of the clear losers before they decimate your portfolio. Ultimately though, many investors, new and old alike, make the costly mistake of holding onto losers hoping that someday they will break even. Selling losers is psychologically hard – it proves you’re wrong. People think that, as long as they don’t sell, the losses are not real losses. Well, they are real and sometimes you just have to accept when you’re wrong.

Folks bear in mind that very rarely do portfolios have 100% winners—even for the best investors. If just one bet in a portfolio out of 10 gave 5 to 10x return, while the losses of the other nine were cut to a minimum, the overall portfolio would produce handsome returns. Investors NEED to control their losses! 

For example, Warren Buffett cuts losses quickly and decisively. He knows that a loss in the stock market is part of the investment process and the key is not letting it turn into a bigger one. In April 2020, deep in the COVID-19 crisis, Buffett sold all of his $4 billion in airline stocks to cut losses. The reason? He saw that the pandemic—a force majeure event—changed the entire investment thesis around travel and that the industry would take years to recover. So he cut his losses. In May 2020, he began trimming his significant bank portfolio, for similar reasons. 

Follow the example of Buffet. Accept when you’re wrong and take the actions necessary to mitigate losses. Remember, it’s much harder to make money than it is to lose it.

If you want to learn more about smart investing please check out our book Ten Commandments of Investing: Guiding Principles from the World’s Greatest Investment Wizards