By: Frank Armstrong, CFP, AIF
Frozen, like a deer in a spotlight. OK, you have done your financial planning, analyzed your existing holdings, and designed an asset allocation plan that meets your needs. You know that all or part of your present holdings do not fit your situation. You have in hand a clear plan, a rational strategy, a path to better future performance, and a portfolio tailored to provide the highest possibility of success. You’re ready to take action.
But, suddenly you are frozen like a deer in a spotlight! You can’t bring yourself to clean out your present portfolio. If breaking up is hard to do, selling your existing stocks or funds can be excruciating.
Lot’s of people get bogged down here. We are talking about people with severely concentrated portfolios, portfolios that they will cheerfully admit are totally inappropriate for their situation! But, they can’t quite organize themselves to take the next logical step. If you recognize yourself here, you are not alone.
Mental barriers to effective action
There are numerous mental barriers to taking effective action. But there are few reasons that come up over and over. At the core of most of them is a fear of making a wrong choice in an atmosphere of uncertainty. After all, nobody can guarantee that any particular portfolio will be better than the one you hold. Not doing anything may look better than taking a chance that you will regret your decision later.
None of us are as rational as we would like to think. Physiatrists will tell you that it’s perfectly possible to hold two totally contradictory opinions at the same time. This, of course, complicates the decision process no end. The probability of paralysis is very high if you are being torn in two.
I want to wait to see what’s going to happen
Especially when the market is unsettled (or, gulp, down!) procrastination may seem like a way to limit future regret. There is nothing like a little market tumble to strike fear into the hearts of previously intrepid investors. But, of course, they all know that a little birdie is not going to land on their shoulder and whisper “NOW” at just the right moment. We can never know what’s going to happen, but the odds favor the properly designed portfolio no matter what happens.
I want to wait for them to recover
People often really hate to sell their losers, because they feel like they are admitting that they made a mistake. They often believe that if they just hold on until the stock recovers, the mistake will disappear. So anxious are they to avoid a “loss” that they can lose sight of the opportunity cost of waiting for an indefinite time for the stock or fund to recover.
Some people can get extremely defensive on this issue. I was interviewed several months ago by a major newspaper financial reporter that asked me what investors with heavy tech holdings losses should do. This writer just wouldn’t/couldn’t accept the answer that if the portfolio was inappropriate it should be liquidated and replaced by one that is. She kept asking me if investors shouldn’t wait for the tech stocks to recover. I kept saying that there was no particular reason to believe that they should perform better than a properly diversified portfolio from that day forward. By the end of the conversation I was sure that if the reporter could have crawled through the phone line and strangled me, she would have. Not surprisingly, the interview was never published. Later I wondered just how many tech stocks she was holding in her personal account.
Want to hold on to the winners
On the flip side, investors with gains in some positions often believe that stocks that have gone up will continue to go up. In an efficient market where stocks are priced based on all available evidence, there is no particular reason to believe that that’s the case.
Investors with large embedded gains may have some legitimate concerns over tax implications. And any rational transition policy will account for taxes. It’s often possible to wash losses against gains, and it may make sense to hold at least until long term capital gains are available. But, the tax tail should never wag the dog. Taxes are only one issue. Potential losses in an inappropriate concentrated stock position may far exceed tax costs of liquidating a winner.
Time to fold ‘em?
The bottom line, is that if your portfolio doesn’t match your objectives, time horizon and risk tolerance the time to adjust it is now, before it bites you, or bites you harder. You have a particular amount of investment capital today. The central question is how it will perform from this day forward. Holding a losing hand while hoping for the best is a formula for disaster. If your portfolio is inappropriate, it’s time to fold ‘em.
The Doctor is in
One very good way to overcome some of the emotional issues is to mentally convert the portfolio to cash. Then imagine yourself standing there with that cash. Would you invest it back into your present portfolio? If the answer is no, then it’s time to take action. Thinking the problem through from this angle has the advantage of separating you from past mistakes, and giving you a mental clean start.