Locking In Losses Is A Dangerous Myth

I am really sick and tired of hearing these BS artists on television telling their callers not to sell their mutual funds or stocks because they will “lock in their losses”. The last time I heard this it was from – who else – Carmen Wang Ulrich. This is probably the most stupid scare tactic ever invented to prevent people who don’t want to learn how to invest from taking action. How stupid is that?

Here’s why it’s ridiculous to even listen to this dangerous myth:

  • What if your stock goes to zero? Or the company goes bankrupt? At what point exactly should you sell? For a mutual fund, how low does it have to go before you throw in the towel?
  • What if while you watch your investment lose money, you see that there are others out there that are making money? Do you not sell to avoid “locking in a loss”? You are guaranteed a loss if you don’t switch to something that’s making money!
  • What if we have another market dive? What if we have zero growth for ten years – just as today’s market has wiped out all of the increases of the past ten? When do you sell in favor of something else? Like a CD?

OK let’s do the math. Investor A and Investor B each have $10,000 in a mutual fund that’s down 30% so they each now only have $7,000. All indications are that the market is still headed down. Or at least, that’s the investors’ fear.

Investor A listens to Carmen and sits there watching it lose another 20% because Investor A believed without knowing why that you shouldn’t “lock in” your loss by selling. Except that now Investor A has $5,600 in her account. (By the way: If you listened to Carmen last October, this is EXACTLY where you would be right now.) She sits there and watches her $5,000 bounce around the bottom of the market, because this is a market like nothing the tee vee people have ever seen before, and they don’t know what to do either. Eventually, the market moves up 10% after six months, but that puts her at only $5,500. She’s a long way off from gaining back her losses.

Investor B instead uses common sense, and doesn’t listen to tee vee “experts”, and sells when her account is down the first 30%, moving her $7,000 to a Ginne Mae (government) bond fund (not actual performance, only an example), earning 5% over the next 6 months, so she now has a $350 gain instead of a $1,400 loss, for a total of $7,350. She now moves $4,000 of that back into mutual funds that she feels confident are now moving up again. Investor B gets the same 10% market move that Investor A got, so she has $4,400 from her move back into mutual funds. And since she’s made 5% on the remaining $4,350 her totals are $4,400 + $4,565 for a total of $8,965 in her account, well ahead of Investor A. (She will now also keep watch on the market and know when to sell and when to buy!)

OK, which person do you want to be?

No matter what the market is doing today, you DO NOT LOSE BY SELLING. This fear of selling is the one characteristic that will definitely make you a loser in the markets every time. You must understand that you will win some, you lose some, when you are smart about investing, you take your losses before they get too big, and move the money to where it will be working for you again. There is no such thing as “buy and hold for the long term”. Those days are gone. Learn what to do now, or stay away from the markets.