The Fleas Come With the Dog

Recently, I wrote about a problem we'd all like to have more often: what to do with your winners. Now, alas, it's time to take a look at the flip side and consider two ways to make the most of your losers.

Option 1: Take your lumps
Sometimes parting isn't such sweet sorrow. As most investors know, it's sometimes more along the lines of, "Good riddance and don't let the door hit you on the way out."

At the very least, if you own a stock that's hit the skids for fundamental reasons -- as opposed to, say, Mr. Market's occasional temper tantrums -- you need to revisit your investment case. If that doesn't hold water, you shouldn't continue to hold the stock. After all, even during turbulent times -- heck, especially during turbulent times -- the market abounds with opportunities, rock-solid companies with long-term track records of success that are trading on the relative cheap.

Holding on to a stock that's a loser for good reason, then, means that, in addition to the direct hit to your portfolio, you'll also suffer indirectly because your moola isn't working for you in a worthier investment vehicle.

On that front, consider that, as I type, the likes of Genentech (NYSE: DNA  ) , Marvell Technology (Nasdaq: MRVL  ) , eBay (Nasdaq: EBAY  ) , and Chico's (NYSE: CHS  ) are all trading well below their 52-week highs despite being the very pictures of fiscal health and sporting five-year earnings-growth forecasts in excess of 20%.

Give me a break
While you're mulling those names, consider too that Uncle Sam provides a tax break as a consolation prize if you sell at a loss. You can use your losses to offset taxable gains, and even if you don't have any gains to offset, you can still deduct up to $3,000 from your "ordinary income" in a given year. If, alas, you have more in losses than you can take advantage of (so to speak) in one year, not to worry: You can save 'em up and deploy them against future gains.

Such "tax-loss carryforwards" are a favorite tool of savvy fund managers -- the kind I call out for special recognition in the Fool's Champion Funds newsletter service each month -- and you should avail yourself of them as you manage your own moola. Fair, after all, is only fair.

Option 2: Average down
Rather than shaking off your losers for all they're worth in tax savings, you might opt to go the other way and "average down" -- i.e., lower your average cost basis by buying additional shares of a company when its in the doldrums. This is the approach to take when, after examining the reasons for the company's sell-off, you decide your investment thesis remains compelling.

When that occurs, it may be the case -- to quote one of my favorite fund managers -- that Mr. Market "is handing out dollar bills for 50 or 75 cents." That's a good time to be a buyer, of course, as folks who purchased Viacom (NYSE: VIA-B  ) , Kohl's (NYSE: KSS  ) , and International Game Technology (NYSE: IGT  ) when they were down in the dumps surely know: Each has bounced nicely off its respective 52-week low.

Make no mistake: Averaging down isn't for the fainthearted. Sometimes stocks that seem fundamentally strong just keep falling for reasons that only become apparent over time. Still, if you're a long-term investor (and you know you are, Fool), snapping up shares when they're trading on the cheap can be a smart move.

The Foolish bottom line
Another smart move is building your portfolio on a foundation of mutual funds and then supplementing it with individual stock picks -- a tack that can take the sting out of the market's inevitable performance gyrations. Not just any fund will do, of course. Indeed, the vast majority of them are underachieving duds.

Enter Motley Fool Champion Funds, where we focus like a laser beam on just those picks that feature battle-tested managers, rock-solid performance histories, and low price tags. Since the debut of our service in March 2004, we've bested the market by roughly eight percentage points -- and with far less volatility than you'd experience with a stocks-only portfolio. Sound like your cup of tea? Good deal. Click here to snag a free 30-day guest pass and see if you wouldn't benefit from adding a few cherry-picked Champs to your portfolio.

Shannon Zimmerman runs point on the Fool'sChampion Fundsnewsletter service, and at the time of publication didn't own any of the securities mentioned above. eBay is a Stock Advisor recommendation. You can check out the Fool's strict disclosure policy by clicking right here.


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