Your stock is down. Stay calm: this may be the chance to buy more.
The board turns red. Your portfolio is in the negative. Your phone fills with panicked messages from the investing groups.
This is where most people make the biggest mistake of their investing lives.
A falling price is not a loss
There is a simple fact new investors tend to forget: a loss only happens when you sell. When a stock falls 15%, 20%, even 30%, if you have not sold, you have not lost. You are looking at a number on a screen.
The right question is not "should I sell to cut my losses?" It is: "is my original investment thesis still intact?"
Separate the two: is it the market, or the business?
Before acting, stop and work out what is actually driving the decline:
- Falling with the whole market: the market is correcting and good companies get dragged down with sentiment. This is usually an opportunity, not a danger.
- Falling on short-term news: a quarter below expectations, a negative macro headline. Judge whether this is a passing event or a fundamental change.
- Falling because the business changed: management turned over badly, the business model broke, the industry lost its competitive edge. This is when a serious re-examination is required.
If the answer is one of the first two, the business is still good and the price is simply cheaper, then you are facing an opportunity, not a disaster. Read more on valuing an asset by value-investing principles before deciding.
Buying the decline: the patient investor's craft
Warren Buffett has a well-known line to the effect that he is delighted when McDonald's cuts the price of hamburgers, because he is a buyer. The same thinking applies to stocks.
When a business you believe in, after careful analysis, suddenly sells for 20% less, that is not bad news. It is the reward for staying calm.
Averaging down only works when you have done the homework: you understand the business, you believe in the intrinsic value, and you are not using leverage. If any one of those three is missing, stop and reassess first.
Calm is a competitive advantage
While the market panics, most retail investors sell out of fear. Those very waves of selling create unreasonable prices, and open the door for anyone calm enough to look past their phone screen.
Global market history has proved this over and over: the people who buy while others are frightened are usually the ones who win in the end. Not because they were lucky, but because they were disciplined.
A checklist for when the portfolio is red
Before you hit sell or buy, answer these:
- Is my original thesis still correct?
- Does this business still have a durable competitive advantage?
- Am I using money I need to live on? (If so, do not buy more.)
- Am I reacting to emotion, or to analysis?
- If the price fell another 20%, do I have the temperament and the finances to hold?
If the answer to 1, 2 and 5 is yes, you should not only hold, you should consider buying more. See also why patience is a long-term investor's weapon.
In closing
In the short term a falling market does not distinguish between good and bad companies. Time does. A good business bought at a reasonable price, or better, a cheap one, proves its value over a long enough cycle.
So the next time your portfolio turns red, put the phone down, make a coffee, and ask yourself: "is this risk, or opportunity?"
The answer is not on the board. It is in the analysis you did beforehand.
Silent discipline. Compound value.