Portfolio Dilemma: how to decide whether to cut a loser or hold on

An ii Community member asks: What are the main considerations when deciding whether to give up on slow or losing investments?

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When it comes to investing, many people will agree that it’s easier to hit the buy button on a new idea or to hold on to a particular share or fund as opposed to calling time on it.

Even when an investment has performed well, it can be hard to judge whether to keep on running it as a winner or to take profits and run.

However, that’s a nice problem to have. For underperforming investments, particularly when in negative territory, deciding whether to hold in hopes of a recovery or to cut your losses before they potentially go even deeper, is a far from straightforward task.

One thing to bear in mind is that percentage losses require bigger percentage gains to recover. For example, a loss of 10% requires a gain of 11% to break even; a loss of 20% requires a gain of 25%; a loss of 33% requires a gain of 50%; and a loss of 50% requires a gain of 100%. 

In a recent On The Money podcast episode, we covered key considerations when deciding whether to keep the faith or sell a fund, investment trust or exchange-traded fund (ETF), while another podcast episode, “How to build a World Cup-winning portfolio”, explained how to tinker with tactics when running your own investments.

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Below, I summarise some of the points made, and also consider what to weigh up if performance for individual shares disappoints.

The first thing to think about is: why did you buy the fund/share in the first place, and does your investment thesis still hold?

While patience is often rewarded in investing, there can come a point when it makes more sense to move on rather than wait for a recovery that may never arrive. Focus on the prospects from here and ask yourself a simple question: if you didn’t already own the fund or share, would you buy it today?

Then consider why the fund or share is underperforming. Is it because the region or industry it operates in is out of favour? If so, a period of subdued short-term performance can perhaps be forgiven. You may even be more inclined to buy more if you think a recovery is on the cards and the valuation of the share has fallen, resulting in it becoming even cheaper than when you first purchased it.

However, if the fund or share is underperforming peers for a specific reason, such as the stock picking not being up to scratch for funds, then you may be more swayed to sell.

Management change is also worth keeping an eye on. If a founder leaves a company or a fund manager departs, you may view this as sign to move on, particularly if succession planning hasn’t been in the works.

For funds, consider how long the manager has been at the helm, whether the new managers coming in have been part of the team for a considerable amount of time, and whether the approach of the fund is remaining the same or changing.

When taking over a fund, some managers ring the changes to put their own stamp on the portfolio, which can change how the fund invests.  

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Also consider whether the fund is still fulfilling the role you intended it to play in your portfolio. For example, if you bought hoping for a certain level of income, and this income isn’t being delivered, you may decide to call it a day.

For those who own individual shares, profit warnings are another key thing to watch out for.

As a company’s share price reflects investors’ collective view of what the business is worth both today and in future, a warning that previous forecasts of profits now look over-optimistic tends to lead to a sharp sell-off.

Following this, there is often a so-called dead cat bounce, which attracts buyers when shares are initially oversold. But what happens next very much depends on the nature of the problem behind the profit warning.

It could be a single profit warning, but there is a saying in the City that “the first cut is the cheapest” and that “profit warnings often come in threes”, so there could be worse to come.

A final thing to consider is opportunity cost. If you are holding a struggling fund or share that could take years to recover, there may be a better opportunities elsewhere. Even if the fund or share recovers, you could have earned a superior return on another investment during the same period.

If you have a question you’d like to be considered in our Portfolio Dilemma series, we’d love to hear from you. Please contact: editorial@ii.co.uk