Education & Insights: The art of cutting your losers

As the second half of the year kicks off we - like many investors, both private and professional - have taken stock of the first half performance of our portfolios.

But in a personal capacity, the first two weeks of the new half mean something quite different. This is Wimbledon season and (even in Roger Federer’s absence), nothing beats Wimbledon season. This year’s pinnacle of the sporting calendar has the added excitement of competing with The Euros and The Tour de France (because after watching the Netflix documentary on the sport, I am now a fully invested tour cycling fan) for space on my screen. The live blogs of all three are permanent tabs open on my computer.

And so, just like every year, I have not yet found the time to assess the first half performance of my portfolio.

That’s not necessarily a bad thing. As I have written previously, my investment mindset is buy-and-hold and I don’t tend to check my portfolio performance too regularly. I aim to buy companies which have all the hallmarks of high quality businesses which can provide compounding returns over the long run. Ill-disciplined or unfocused checks of the performance of those stocks - especially during a period of weakness - can be incredibly disappointing. And reacting to that disappointment can be costly.

I know I am not the only investor who struggles with the challenges of investment psychology. Ahead of a Q&A session we hosted with Robbie Burns, we reached out to our community for questions to put to him and two thirds of the questions which came in were about the mentality behind buying and selling decisions.

You can catch up with the full Robbie Burns interview here, but I thought I would draw out one of his pearls of wisdom which I found especially interesting: don’t lose money.

Not losing money is also one of Warren Buffett’s famous mantras and what both he and Robbie mean when they highlight the importance of not losing money is that investors shouldn’t be afraid to cut their losses.

Now this is something that I have long struggled with and perhaps that is partly because of my mentality as a buy and hold investor. I research stocks thoroughly before I buy them and only add them to my portfolio when I am fully convinced of their quality and growth (or sometimes recovery) potential. The trouble is that I am sometimes too convincing and if the price starts to dip I continue to convince myself that the market is wrong. Holding on for too long has left me with some horrible losses which sit in my portfolio and impact the overall performance.

By contrast, Robbie says he is very disciplined in cutting his losers. He sets stop losses to ensure there is a limit on the amount he can lose on any one stock, meaning there are no big red marks in his portfolio. Robbie is not saying he’s perfect, he has also stomached some horrible and expensive losses in the past (which he talks about in the webinar), but it is those experiences which have taught him the importance of not losing money.

Setting stop losses and a limit on the amount of money you can lose on one share is excellent advice for any investor, regardless of the type of strategy they pursue. Once Wimbledon is over and I find some time to look at my personal finances I will consider how much money I am willing to lose on one stock and I then I will look at my portfolio to see whether any of them have hit that limit and if (given the recent market environment) I should consider cutting my losses.