An old investment adage says people find losing money much more painful than the joy they get from earning the same amount.
This explains why almost everyone — retail and professional — ends up making a massive basic mistake on their way to investment wisdom.
Say you bought Nuix Ltd (ASX: NXL) shares in January when they were flying at $11. What a great company with a great product — the future’s looking good!
Then you see the stock plunge to $6 in February after a downgrade to their financial forecasts.
What do you do? You’ve lost almost half your money.
Many novices, and even some veterans, will buy more shares. The stock is cheap now — buy low, they think.
For God’s sake, don’t double down on a loser
But as Cyan Investment Management portfolio manager Dean Fergie reminds us, doubling down on your mistakes is never a good idea.
“One thing that is completely non-negotiable is we do not throw good money after bad,” he told this week’s Ask A Fund Manager.
“We don’t prop up businesses that aren’t going well because we think the price has got too cheap… We will let other people do that. We never follow any business that’s going down. We never keep topping up.”
Fergie admitted psychologically people can’t help putting more money into their losers. The loss pains them and they get sucked into thinking that’s the way to recover.
“It’s an emotionally difficult thing to do, because it’s like, ‘Oh, I’m going to prove the market’s got this wrong’ — but it’s just silly.”
Copping a loss is not the end of the world
Exiting when a company is clearly failing and the original investment thesis doesn’t hold is a wise move, not an admission of failure.
If you double down, you’ll expose even more of your money to losses.
Fergie told The Motley Fool that losses are part of the experience.
“The thing with long-only investing is that it’s an asymmetrical outcome. You can’t lose more than 100%, but you can make much more than 100%,” he said.
“So you don’t even have to get 50% of your calls right. You just got to make sure that the ones you get wrong, you don’t double down on and keep throwing good money after bad. And the ones that go well, you let those profits run.”
For the record, if you doubled down on Nuix in February at $6, you would have lost even more. The stock was trading at $2.67 at the close of trade on Monday.