One of the hardest decisions in investing is knowing when to admit that an investment has not worked out.
If you buy a share or fund for £10,000 and it subsequently falls to £7,000, selling can feel like accepting defeat. Until you sell, the loss can seem temporary. There is always the possibility that the investment will recover and you will eventually get your money back.
This creates a powerful temptation to hold on.
But investing should not be about getting back to the price you originally paid. The more important question is much simpler:
If you had £7,000 in cash today, would you choose to invest it in this investment now?
If the answer is no, continuing to hold it may be a mistake.
A Loss Is Already a Loss
Investors often distinguish between a “paper loss” and a “realised loss”. Technically, there is a difference for tax and accounting purposes, but economically the distinction is less important.
Imagine you invest £20,000 in a company and the shares subsequently fall by 30%. Your investment is now worth £14,000.
You may tell yourself that you have not lost £6,000 because you haven’t sold.
But your portfolio is still worth £6,000 less.
The market does not know what you originally paid for the shares, and it certainly does not care. Your purchase price is relevant to you, but it tells us very little about what is likely to happen next.
The question should therefore be whether that £14,000 is still invested in the best place for your objectives.
Why Selling at a Loss Feels So Difficult
There is a well-established behavioural explanation for this. It is known as loss aversion.
Research into behavioural finance has repeatedly shown that people generally feel the pain of losing money more strongly than they enjoy making an equivalent amount.
That can lead to an interesting contradiction.
Investors may happily sell an investment that has risen 30%, locking in their profit. Yet they can be extremely reluctant to sell another investment that has fallen 30%.
This can result in investors repeatedly selling their winners while retaining their weakest investments in the hope that they eventually recover.
There is even a name for this behaviour: the disposition effect.
Good portfolio management should try to avoid allowing the price you originally paid to dictate what you do next.
The Investment Doesn’t Need to Recover – Your Money Does
Suppose you invested £10,000 into Investment A and it has fallen to £6,000.
You believe there is a reasonable chance it could eventually recover to £10,000, so you decide to wait.
But imagine there is another investment, Investment B, which you now believe has considerably better prospects.
Your choice isn’t really between:
Selling for £6,000 or waiting until you get your £10,000 back.
It is between:
Keeping £6,000 invested in Investment A or moving £6,000 into Investment B.
That is a very different decision.
To turn £6,000 back into £10,000 requires a return of approximately 67%. It doesn’t matter whether that return comes from the investment that originally lost the money or from something completely different.
Your portfolio needs to recover. The individual investment doesn’t.
Ask Whether the Investment Case Has Changed
This does not mean investors should automatically sell whenever something falls in value.
Far from it.
Volatility is a normal part of investing. Excellent companies, investment funds and even entire stock markets can experience substantial declines before recovering.
A falling price alone is therefore not necessarily a reason to sell.
Instead, return to the original reason you bought the investment.
Perhaps you invested in a company because you expected revenues and profits to grow rapidly. If the share price has fallen because markets have temporarily become nervous while the underlying business continues to perform well, selling could be exactly the wrong decision.
However, if revenue growth has stalled, debt has increased, competitors are taking market share and the company’s original opportunity has deteriorated, continuing to hold simply because the shares are below your purchase price makes little sense.
The investment case has changed.
The same principle applies to funds. A fund may no longer fit your investment strategy, its management team may have changed, or you may simply have identified a more appropriate way of gaining exposure to the same market.
Losses Can Sometimes Have a Tax Benefit
For investments held outside tax-efficient wrappers such as pensions and ISAs, selling at a loss can potentially have an additional advantage.
A realised capital loss can generally be used within UK Capital Gains Tax rules to offset taxable capital gains. Depending on the circumstances, unused allowable losses may also be carried forward against future gains, provided the relevant reporting requirements are met.
For example, an investor may have made a substantial gain selling one share but have another holding sitting at a significant loss. Realising the loss could potentially reduce the overall gain subject to Capital Gains Tax.
This is sometimes referred to as tax-loss harvesting.
Tax should not be the sole reason for making an investment decision, and there are rules to consider if you intend to repurchase the same investment shortly afterwards. However, sensible tax planning can form part of the overall portfolio management process.
Don’t Confuse Price With Value
Another common mistake is assuming that an investment must now be “cheap” simply because its price has fallen significantly.
A share that has fallen from £20 to £10 isn’t automatically a bargain.
If the company’s prospects have deteriorated enough, £10 could still be expensive.
Conversely, a share that has risen substantially isn’t necessarily expensive. If profits and future expectations have increased even faster than its share price, it could still represent attractive value.
Successful investing therefore requires separating price from value.
The fact that an investment is below the price you originally paid is not, by itself, an investment case.
Think About Opportunity Cost
Every pound invested in one asset is a pound that cannot be invested somewhere else.
This is the opportunity cost of continuing to hold a poorly performing investment.
Imagine you hold £25,000 in an investment that you no longer particularly believe in. You keep it because you are waiting for the price to recover.
If it spends the next five years going nowhere while another suitable investment rises substantially, the cost of your decision isn’t simply the lack of recovery. It is also the return you could potentially have earned elsewhere.
This is why portfolios should be reviewed based on what you believe offers the best combination of risk and potential return from today onwards, rather than what happened in the past.
Diversification Makes Selling Easier
One reason investors become emotionally attached to losing investments is that individual holdings can become too important to them.
A properly diversified portfolio can help reduce this problem.
If your financial future depends heavily on whether one particular company recovers, you may have taken more company-specific risk than necessary.
Diversification means accepting that not every investment will be a winner.
Some companies will exceed expectations. Others will disappoint. Occasionally, an investment thesis will simply turn out to be wrong.
That isn’t necessarily evidence of poor investing. It is an unavoidable feature of investing in an uncertain world.
What matters is how you respond when the evidence changes.
Forget What You Paid – Focus on What You Own
Perhaps the most useful exercise is to imagine starting your portfolio again today.
Ignore the original purchase prices for a moment and look at each holding.
If the entire portfolio were converted into cash this morning, would you buy exactly the same investments again in exactly the same proportions?
Where the answer is yes, there may be a strong case for continuing to hold.
Where the answer is no, it is worth asking why you still own it.
Selling an investment at a loss can be uncomfortable because it forces us to acknowledge that a previous decision did not produce the outcome we hoped for. But investing is not about proving that every decision you made was correct.
It is about allocating your money intelligently from this point forward.
Sometimes that means allowing a good investment time to recover from temporary volatility.
And sometimes it means accepting a loss, moving the remaining capital elsewhere and giving that money a better opportunity to grow.
The important thing is to understand the difference.
Carl Roberts, Director
If you want to learn more about this topic, please find the link here.
More information about our fund, the YFS Intelligent Wealth Fund, can be found here: Hargreaves Lansdown or AJ Bell.
Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
