Several investors believe that money can be
made by buying the right investment at the right time. If they select a good
investment and time their decisions well, they think it's enough. They never
tire of ruing the investing opportunities they've missed. However, the same
attention is not paid to the bad investments in their portfolios. In reality,
an investor's portfolio suffers more due to the incorrect decisions that are
not acknowledged and corrected. Holding bad investments may be worse than not
selecting the right ones.
While the entire universe of investments is
potentially available for buying, the decision to sell only involves what the
investor already has. It is, therefore, pragmatic to focus on holding the best
rather than wondering about what we may have missed.
According to behavioural economists, one of
the main reasons for our refusal to sell an investment is our aversion to loss.
If our investment turns out to be good, we are happy to sell and feel good
about the gains. However, booking a loss is painful, so we tend to postpone the
regret we feel at having made the wrong decision. We choose to wait out,
ignore, or worse, add more to a poorly performing investment, hoping to average
out the cost. Therefore, cleaning up a portfolio is a tough task and calls for
rational decision-making. Here are three ways to discard the bad apples from
your portfolio.
The rate of return of a portfolio is the
weighted average of what we hold in it. If some of our money is stuck in bad
investments that show a negative growth, or don't work as hard as the others,
we are losing out on the overall gains. If the money from a bad investment is
released and redeployed, it may end up doing better.
If we are reluctant to make the decision,
it may help to begin with a partial liquidation of the investment that is
performing poorly and comparing it over a period of time. When we see how the
loss could have been arrested and funds redeployed, we may be able to rebalance
the portfolio with greater confidence. For example, those who are still holding
the JM Basic Fund bought in 2007 in the hope that they will recoup the loss,
should liquidate the fund and pick an index fund to see the benefits of selling
what is not working.
We also have to give up the urge to come
out good even after we know that our investment decision was bad to begin with.
Ignorance is not a pardonable error in investing and when time reveals our
decision as a bad one, it is better to act than argue. An endowment policy that
was bought to save taxes, a Ulip purchased assuming that it is an investment
for a fixed period, low-priced stocks picked at market peaks when good stocks
seemed expensive, NFOs bought on an erroneous understanding of the product are all
bad investment decisions, ab initio. They will not become better with the
passage of time.
However painful the decision, we may have
to book the losses arising from the purchase of a bad product. The sooner it is
done, the better it is for the investor. Many of us think we should recoup
something from the investment. If the performance is poor because the market
cycle turned down, it may be worthwhile waiting for an upturn. If the market
improves and our investment fails to look up, it confirms the bad choice and
the need to quit.
Several investors want to know when to sell
and ask frequently about profit booking. The crux of good wealth management is
in wisely booking the losses and having a strategy for weeding out bad
investments. If such investments are recognised for their draining impact on
the portfolio and are uprooted ruthlessly, the fruits of investing are bound to
be sweeter.
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