This Mistake Could Cost You a Fortune

Man, was that ever a brutal year or so ...

Granted, it's not like I bought AIG (NYSE: AIG  ) or Fannie Mae (NYSE: FNM  ) in the summer of 2008 -- although I know people who did. And I certainly didn’t listen to any of the doom-and-gloom pundits who suggested you short banks like Wells Fargo (NYSE: WFC  ) or US Bancorp (NYSE: USB  ) just before their epic rebounds.

But I did move back to Big 12 country just in time to see my beloved Oklahoma Sooners lose game after game after game -- not to mention lose their Heisman-winning quarterback, Sam Bradford, to a season-ending shoulder injury mere minutes into their opener.

You see, my grandfather played football for Oklahoma, and I've been rooting for them since I was old enough to walk, so 2009 was a pretty painful year for me. But don't worry, I'll always be a Sooners fan -- no matter how bad things get. In sports, that's a virtue.

Wall Street, though, is a different ball game
For proof, just ask any longtime "fan" of:

Stock

10-Year Return

Yahoo! (Nasdaq: YHOO  )

(82%)

Xerox (NYSE: XRX  )

(53%)

General Electric

(53%)

Dell

(62%)

Bristol-Meyers Squibb (NYSE: BMY  )

(37%)

Data provided by Yahoo! Finance.

Or ask my fellow Fools Rich Greifner or Adam Wiederman. Or even ask Jim Cramer. In his book Real Money, Cramer reminds investors, "This is not a sporting event; this is money. We have no room for rooting or hoping."

Yet it happens all the time -- and time after time, investors ride stocks right into the ground because they're emotionally attached to a company's story, products, or management.

I, for one, am sitting on a major loss in Clearwire. And if we're being honest, the only reason I bought shares in the first place was because I liked that it was backed by Google, Comcast, and a handful of other tech heavyweights.

Ditch that loser!
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."

To a sports fan, that might seem cruel and unusual, but is it good investment advice?

To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. You see, they often rerecommend a stock even after a big run-up -- or a sharp fall.

As it turns out, I found three examples when breaking IBD's rule actually paid off big-time:

Stock Advisor Pick

Decline After Recommendation

Gain After reRecommendation

Netflix

23%

383%

Quality Systems

14%

1,000%

Dolby Labs

10%

170%

These weren't flukes, either
In his rerecommendation write-up for Netflix, David Gardner admitted, "We're currently sitting on a 23% loss." But he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."

And he had well-thought-out reasons for continuing to own the stock: "It remains first and best in a growing industry, creates convenience for millions of consumers, and is led by visionary management that markets aggressively." Netflix stock has risen 379% since then.

So when do you sell?
Many investors have hard-and-fast numerical rules. Others -- like the Gardners -- stick to a more analytical and intellectual approach to determine when to recommend that their Stock Advisor subscribers sell a stock. So when do David and Tom Gardner consider dumping a stock? Primarily when they encounter:

  • Untrustworthy management.
  • Deteriorating financials.
  • Mergers, acquisitions, and spinoffs that could damage the business.

The debate rages on
Investors may never agree on when or why to sell a stock. But it is important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses -- or miss out on massive gains.

For what it's worth, David and Tom Gardner rarely sell, and it works for them. In fact, Tom's average Stock Advisor pick is performing more than 35 percentage points better than a like amount invested in the S&P 500. Meanwhile, David's are performing 63 points better on average.

If you'd like to see which stocks David and Tom are recommending investors buy (and sell) right now -- including their two top picks for new money -- you can take a free 30-day trial of Stock Advisor.

In addition to all of their stock picks and research, you'll also get full access to exclusive members-only discussion boards, where you can swap thoughts about when to buy or sell a stock with thousands of other dedicated investors.

To learn more about this free, no-obligation 30-day trial, simply click here.

This article was first published Dec. 28, 2007. It has been updated.

Austin Edwards owns shares of Google and Clearwire. Dolby, Netflix, and Quality Systems are Stock Advisor picks. Google is a Rule Breakers pick. Though generally not a sports fan, the Fool's disclosure policy enjoyed watching Oklahoma upset Toby Gerhart and the Stanford Cardinals in the Sun Bowl. Boomer Sooner!


Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 12, 2010, at 7:03 PM, sothonod wrote:

    I'm not sure about "Ditch that loser! "

    I bought my ClearWire stock when it was under $3.00 last year same month and it is now above $6.00.

    A - Let suppose that T-mobile and Sprint get together in 2011 or before.

    B - Before LTE even start Wimax will have several million clients that could seamlessly move to Sprint LTE when ready.

    C - Potential niche market for ClearWire if they decided to stay with Wimax.

    What would happen to my ClearWire stock if A, B or C?

  • Report this Comment On February 12, 2010, at 11:31 PM, alldaycricket wrote:

    The one glaring omission in this article is that if you use the 8% sell rule to get out, nothing prevents you from getting back into a stock later. You don't have to sit through a 23% loss. Get out at 8%, put you money in a savings account or another stock or some place, any place, where your money can work for you, then get back in as the stock swings back up. The rule doesn't say "get out at 8% and stay out for life!"

    This article really offers some terrible advice. If someone gets out of Netflix when it is down 8%, they can just ride out that 23% loss without a worry. What this article doesn't tell you about is about all the stocks that went down 8% or more and NEVER CAME BACK UP! The author hasn't disproved Bill O'Neil's thesis at all! I get out at 8% every time. I got out of WATG, which I bought in December at nearly $14. It's now at $8.91. I can just jump back in if I want when I see the stock improve. But I'm had my cash available to move into other positions, which I did and made back my 8% and then some.

    I also resent the implication that the 8% sell rule is somehow not intellectual or analytical. What's that about? What nonsense.

    The author even admits that he's sitting on a loss with Clearwire. Why would you take advice from someone like that? Does the author want others to suffer just because of his stupidity?

    Jumping out at 8% just means your timing was bad, doesn't mean your stock won't rebound. I'm so glad I avoided the whole Motley Fool web site when I was just learning to invest. It could really have done some damage, between the bad advice and the relentless stock pumping. The author's three examples (three! Only three! Statistically, that's ZERO) do not disprove a rule.

    Does the Fool have anyone over there minding the gate for terrible advice like this? Maybe hire some editors, please?

  • Report this Comment On February 14, 2010, at 12:21 PM, mcmic wrote:

    While I agree with you as far as selling out when you lose 8% or whatever your general rule is I think that you can make your argument without attacking the author or the Motley Fool company.

    What I really got out of this article is that you need a hard and fast rule that you are willing to execute. If that rule is cut and run at 8% or investigate why it dropped 8% and make a decision from there then so be it. But just because he is sitting on a potentially bad investment and not willing to perform his loss rule doesn't make him wrong, or you right. I think you would be taken a bit more seriously if you made a non-aggressive argument detailing how the 8% rule has worked for you and/or what alterations you have made to make it suit your style of investing. In other words, show the other side of the coin instead of saying heads is stupid.

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