Client Question: Under water positions

May 4, 2023

In reviewing a portfolio with clients this week, we were discussing a particular holding that was under water (valued at less than they paid for it). We had a good discussion about how to approach positions in an unrealized loss status and I thought it would be worth sharing

Investing in public markets is a real-time event – prices of securities are changing every second. As a result, it is almost a guarantee that at any point in time, positions you hold in your accounts will either be at a gain (worth more than you paid) or a loss (worth less than you paid). These changes in values are referred to as unrealized gains and losses (as they will only be realized (ie: recorded as capital gains and losses) in the event you sell). Should you pay attention to that relative position when evaluating a security (hold, sell, or add more)? Today we will talk thru positions in an unrealized loss and how I think about them.

Let’s consider a security in an unrealized loss – it has done worse than you thought and you’ve lost value on that holding. Does it need to be sold? In my view, unrealized losses are not necessarily indicative of an investment that needs to be sold for the simple reason that the stock price does not always accurately capture the fair value of the business. If you have done the work to value a company, understand its operations and future business opportunities, and remain confident in your thesis and price target, don’t let the change in price discourage you. (And if you hold a mutual fund or ETF in a loss, consider whether your reason for holding the index or collection of individual securities has fundamentally changed).

However, if the business thesis (or underlying backdrop for the industry) has changed, you may wish to move on and adjust your strategy.

Seems straightforward right? This is not always the case.

As human beings, we tend to fall prey to our underlying biases. One such bias is anchoring – where our mind latches on to some data point and can’t let go. When it comes to selling at a loss, sometimes investors hesitate as they are “anchored” to the purchase price. When this occurs, they may decide to wait until the prices comes back to purchase price and they can then “break even.” Breaking even would mean we didn’t make a mistake right? Not necessarily..and I don’t advocate for falling into this bias.

At any point in time, your portfolio value is the capital you have to allocate – and you should choose the highest and best use of that capital. The goal is not to have every position come back to your anchored value and your goal is not to never lose money on any position. The goal is to have your aggregate portfolio return reach your goals. That will be a collection of wins and losses.

Try to avoid anchoring and focus on the thesis/base case for original investment. If the thesis or backdrop of an investment has changed, take the loss, learn the lesson, and redeploy.

The other factor to consider (in taxable/non retirement accounts) is the tax impact. Taking losses can help your taxes (offsetting capital gains and redacting ordinary income (by $3,000) if they exceed gains). While we never suggest letting taxes be the primary motivator, if you need added incentive to move on for loss positions, perhaps taxes can be that motivation.

Taking a loss can be a mental hurdle – but it will get easier in time. Let it go, learn the lesson, and adjust as necessary. Invest on!

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