Letting go is hard to do, even if it's with a losing stock. Unfortunately, this psychological drive to make every stock a "winner" tends to be a money-losing proposition. As you do your year-end portfolio review, consider the following three factors that favor booting your dogs.
First, your losers tend to remain losers, while your winners tend to remain winners. Such was the conclusion of Terrance Odean, a finance professor at the University of California, who in 1998 published a report entitled, "Are Investors Reluctant to Realize Their Losses?" Odean studied the trading records of 10,000 investors and found that individuals tend to hold their losers too long and sell their winners too soon. Over periods of one and two years, the winner stocks that were sold tended to outperform the loser stocks that were held -- by an average of about three percentage points in each time period.
Second, perish the idea that selling equates "giving up." Think, rather, of selling as "taking a timeout." If a stock falls a material level from your purchase price -- say, 20% -- you may want to automatically take a timeout. Once you're on the sidelines, you'll be free from the emotional baggage of owning the stock, thereby enabling you to objectively reevaluate the company and any issues weighing on the stock. If, after a thorough review, the stock still seems attractive, you can always repurchase. No harm done, and you may in fact have prevented much larger losses. Also, in a taxable account, as long as you don't repurchase within 31 days, the taxable loss can be used to offset other gains.
Third and finally, Uncle Sam offers some nifty incentives for selling your losers. These losses, whether short or long term, can be used to offset gains up to $3,000. If you're in the 27% bracket, selling enough loser shares to generate a $3,000 loss will save you about $810 in taxes. (That's just one of several portfolio-pruning tax tips.)
Yes, it's tough to say goodbye to a stock that initially showed so much promise. But if you keep the above three factors in mind, it'll help you overcome the emotional pull of those puppy dog whines.
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