August 24, 2010
In my case, on the other hand, and thanks to enduring 25 years of seeing my mistakes calculated in real time and to the penny, I've evolved into a proud and well-documented quitter; there's a benefit to not waiting in vain for the fix-it fairy to show up.
And so with that in mind, I now share with you my "4 Lessons for Cutting Losses in Life That I Learned as a Portfolio Manager":
Expect to make at least three mistakes every day. The goal in investing is not to avoid mistakes… it's to pick more winners than losers and to make sure the winners benefit you more than your losers cost. It's the same in life.
If you deliberately anticipate multiple mistakes every day, you'll see that they soon lose their sting and have little impact on your self-esteem. When you can eye your mistakes dispassionately, you'll have a better hit rate in deciding whether to quit or persevere.
Plan your exit strategy on the way in. Anytime you have a high-stakes decision to make – and before you take the leap – take the time to map out a possible range of outcomes and the milestones along the way which will cause you to take action.
In the case of our holdings, for example, we list what we expect to happen over a specified period of time and map out the best, worst and most likely cases. We do this before we're emotionally invested in a position, a discipline which helps to clarify when and under what circumstances it's time to walk away.
Just sitting down and asking yourself, "How will I know this is a mistake?" will mean that you won't bankrupt yourself while trying to show the world you're infallible.
Check your shining armor at the door. Many of us like to star in the soap opera that is our life; we feel most alive when there's a dragon to be slain (even if it's of our own creation). After all, killing a monster is a lot sexier and more exhilarating than cultivating a garden.
But we've learned the hard way that a position that requires too much energy- where there's so much data drama that you can't clearly see what's at stake – is the one that will bury you. You can't make a good decision if you're caught in an emotional maelstrom. For us, a lack of clarity about what we don't know equals a sell decision.
Don't let your past drive your future. Regardless of how you may feel about money, it has no emotional relationship with you. Money already spent is a sunk cost and you need to keep its weight from sinking you.
Every day we look at our portfolio of stocks and pretend not to know how much we paid for them. Because the fact is, it doesn't matter whether we're underwater or sitting on a tidy profit. The only relevant question is, "Do we want to own these at this price?"
We can't let protecting our egos get in the way of preventing our clients from losing more money. All decisions – life, business or investing – should only take into account future costs and benefits.
Maybe, after all, I'm less of a masochist than I think. Stockpicking forces you to eat large doses of humble pie, but it also turns out to be a pretty good diet for the soul. And while I make just as many mistakes in life as anyone else, I'm able to cut my losses and move on a lot faster, thanks to all that practice I've had.
When you're banging your head against the bricks of life, from romance to business, knowing when to get out is at least as important as knowing when to get in.
Speaking of "Should I Stay or Should I Go"
Click here if you are interested in reading just why some investors tend to hang on to their losers longer than they should. Michael Ervolini (Cabot Research) says that "people derive more pleasure from buying than from selling."
* Mariko O. Gordon is founder, CEO and CIO of Daruma Asset Management, a NY-based small cap investment management firm. Subscribe to her free monthly e-newsletter On Daruma’s Watch here.
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