Money Rehab with Nicole Lapin - When to Cut Your Losses on a Stock

Episode Date: December 22, 2021

… We know what we said in yesterday’s episode: don’t get off the rollercoaster in the middle of a ride. That’s totally true. But at the same time, there are exceptions where you should cut your losses. Today, Nicole walks you through what those exceptions are, and how to handle them. Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. In yesterday's episode, I talked about how the stock market is a roller coaster,

and you shouldn't get off the ride in the middle. And that is 100% true. However, you also need to know when to cut your losses, and sometimes that will mean selling a stock for less than what you bought it for. I know what you're thinking. You're thinking, Lappin, wait! So far, the strategy for buying low and selling high has been about playing a long game. Like, dollar cost averaging is all about making investment contributions over time, right? Capital gains taxes are all about

holding onto investments for over a year. And you just told me not to get off the fucking roller coaster and now you're changing your tune? What the actual hell? Okay, so yes, all of those things are true. But holding onto a stock is only the right move if you are sure that you've made a good investment. Here's the key. The market plummeting means something entirely different to an individual's stock price plummeting. As I mentioned in yesterday's episode, the market is very good at rebounding, but the stock value of failing companies won't rebound. They will just fail.

If the market crashes, it could be due to a multitude of reasons. A war, an election, a casual pandemic. Something that makes Americans feel that the future is uncertain. A market dip doesn't necessarily mean that the stock market is failing, but more likely indicates a rough financial time across the board. A dip in stock price, on the other hand, could be due to fundamental problems with the company you invested in. There are bad times and bad investments. Don't confuse the two. The difference between market trends and individual stock trends gives us an initial framework to evaluate whether it's time to consider cashing out on your investments.

If one of your stock prices is down and the market is down, it doesn't indicate that you necessarily made a bad investment. It might just mean that everything is down. However, if the market is steady and a stock price is falling, you should take a hard look to see if there's a reason to believe this company will turn around or not. Think about it this way. Say you started law school, took your very first test, and flunked. Absolutely failed. Tanked it, big ol' F, F minus, whatever the lowest thing is. The whole exam has red marker scribbles all over it. You might panic, think that you're

absolutely doomed, not meant to be a lawyer, and then start the paperwork to drop out of school. But what if you heard that everyone failed that test and everyone that has ever graduated from that law school failed the first test? Even the very best top paid lawyers in the country. Well, then you're probably not going to drop out, right? You're going to assume that this was just a really fucking hard test and that you can prove yourself. But if you failed the test and then you find out that everyone else aced it, well, you might start to think that this test

is an indicator that you're not going to perform as well as your fellow students. That's how you should think about a losing stock in a steady market. It's an indicator it's not going to perform well compared to your other stock classmates. When exactly you cut your loss is up to you and your risk tolerance. Just don't fall for what we call in the biz as the break-even fallacy. A really common mindset with investors is that if they see a stock price tank and decide to sell, they assume the price will recover a bit, which to be fair, does often happen. So they say they'll wait until the stock gets back to the price they bought it for, then they'll sell. That's the breakeven fallacy. And it's exactly that. A fallacy.

The problem with this mindset is that people don't do the math correctly when thinking this over. They think, damn, my stock has gone down 30%. Shit. So it needs to rebound 30% in order for me to break even. Not great, but stranger things have happened, right? Wrong go. I know it doesn't immediately make intuitive sense, but let's double click on an example. For easy math, let's say you invested $100 in a stock that went down 30% to a new stock price of $70. Now, say the value did rebound 30%. You may think that means you'll get your original investment of $100. But no, no, my friend, that is not how this works. When you do the math, you'll find that a 30% growth of $70 is $91. And $91 is not your original investment of $100. Nope, it's a little bit short. If you lost 30% in an

investment, the stock price would actually need to rise 43% before you broke even. Take it from someone that's pretty clumsy. Falling down takes a whole lot less effort than climbing back up. And the same thing is true for stock prices. The farther the price of a stock falls, the harder it's going to have to work to climb back up to where it fell. Let's look at an example with a bigger drop. If a stock falls 50%, how much does the price have to rise from that point before you break even? 100%. In other words, if you lose 50% on the value of a stock, the stock price is going to need to double in order for you to break even. And the more you lose in an initial dip, the longer it takes to break even. For today's tip, you can take straight

to the bank. If one of your investments has taken a nosedive recently, take a look at how its patterns compare to the patterns of the overall market or that sector. In most scenarios, I will recommend that you brave the storm and hold on to your investments during market dips. But if the price of one of your investments is dropping dramatically when the overall market is stable, you need to take a hard look at why that investment is crashing and whether it's time to get out.

Money Rehab is a production of iHeartRadio. I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Mike Coscarelli. Executive producers are Nikki Etor and Will Pearson. Our mascots are Penny and Mimsy. Huge thanks to OG Money Rehab team Michelle Lanz for her development work, Catherine Law for her production and writing magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it

all.