When to Hold and When to Fold

How to manage a drawdown

In times like these, where markets are well off their recent highs, you may find yourself in one of the more perplexing investing situations - holding companies you like with significant losses from where you bought them. For those of you with a long memory, the spring of 2021 was a buzzy year in the market, particularly in micro-cap land. The day trading frenzy brought on by Covid lockdowns was in full force. Several of my investments became multi-baggers in short order. I sold several more speculative positions near the peak. I dutifully looked for and found companies with less frothy valuations and put my proceeds back to work.

Long before my arm started to get sore from patting myself on the back, my new investments began to drop. There commenced a long slide that significantly dented the value of my account. At that point, I faced the problem mentioned above: I now had several underwater positions to the tune of 50%. What to do? The simple answer, you re-examine your situation and see if it warrants holding or folding. As with everything in investing, this is harder than it seems.

For one thing, there is commitment bias. You own this thing. Selling is hard. You studied the company. Assuming it’s still doing its thing (if it’s not and you were wrong, sell and move on), you may not want to sell it. Also, we are wired to avoid losses. Unconsciously we may be waiting to “get back to even.” Bottom line: I do not always think straight when evaluating these. Seeing a red position when logging into your account can be psychologically challenging. Waiting can be fine, particularly if you have conviction in the company’s performance despite the drop. But I found that sometimes I’m just fooling myself. I’m not waiting; I’m avoiding a decision.

I force myself to do something if I suspect that’s the case. This is just my framework, and there is nothing special about it. But forcing yourself to act changes your perspective enough to see your investment in a new light. Here are my two avenues:

Sell it all: Just sell it. Then see how you feel afterward. I stumbled on this while back doing some tax optimization. I sold a position with a loss, intending to repurchase it 31 days after the wash sale rules expired. Then after selling, I realized it was not a company I wanted to own and never repurchased it. If I suspect I’m hanging on for psychological reasons; I sell to see how I feel about it. I can repurchase it later if I find out it is a mistake. It’s amazing how differently you can see a position once you no longer own it. Once, I did this and felt relieved the next day. That’s definitely a sign.

Buy a little more: If you liked it at $10, you should love it at $5. Right? Buying more can also help you see if you want to hold a company. Often when I do this, I find myself pleasantly surprised by my new, lower, cost basis. If I feel that way, I’m comfortable owning a company I’m confident in for the long term.

These are just little mind-hacks that I’ve played with over the years. Yours will likely be different. Doing something when you are sitting on an unrealized loss could help change your perspective on your investment enough to make a more rational decision.

Sorry for the publication delay. And the short note. We moved this weekend. Here’s our new view!