Getting Back to Even is Hard - So Limit Your Loss (from ICMA.org)

Recovering from a Decline
Chart of the Week for March 11 - March 17, 2011
When developing an investment strategy, it is important to consider the risk of a decline in a portfolio's value as well as the probability of an increase in its value. Perhaps, it is even more important.

The above graph illustrates the asymmetric relationship between various levels of investment gains and losses. For example, if a portfolio starts with a $100 value and it declines by 10% to $90, it requires an 11% increase to get back to its original $100 value. The disparity gets more pronounced as the magnitude of the decline rises. From the stock market high in October 2007 to its low in March 2009, the stock market, as represented by the S&P 500 Index, dropped 57%. To get back to its original value, it must rise 132%.

All investments involve some degree of risk and investors should focus on the possibility of loss as well as the possibility of gains. As illustrated, the percentage gains required to offset losses are greater than the percentage losses involved. Care should be taken before risky investments are added to a portfolio to ensure they are consistent with one's personal goals, risk tolerance, and time horizon.

© Copyright 2011 ICMA Retirement Corporation, All Rights Reserved

When to Sell an Investment (from the Dolans)

Know When to Fold 'Em!
by Ken Dolan November 21, 2007 02:37 PM

We know that deciding whether or not to sell an investment can be agonizing. Selling too late or too soon is one of the biggest sources of investor regret. But to be a truly successful investor over the long term, you must not only know when to buy, you must know when to sell.

Use these guidelines to decide when it's time to take your money off the table.

1. SELL when the investment has produced the gain you hoped for. In other words, take your profits to the bank. Set a target gain on the day you buy an investment and stick to it. It's easy to become attached to a winner, hoping it will keep going up. Having a target will help take the emotion out of your decision.

2. SELL if you're losing sleep over an investment. If you're up nights worrying that you'll lose some profits if the market goes down, or worrying about whether your investment will ever go up, it's time to sell. It's just not worth it. There are plenty of other opportunities that will let you sleep well at night.

3. SELL if there is a change in circumstances - for you or the investment. Maybe there's been a change in your life. Perhaps your ability to handle investment risk has changed due to job loss or because you are getting closer to retirement.

Or perhaps the company has a management shake-up, or a mutual fund changes portfolio managers. Should you automatically sell? No, but you should monitor your investment closely for three to six months and be prepared to sell if the investment's performance is negatively affected.

4. SELL when you make a mistake. Nobody picks a winner every time. Making mistakes is part of investing. Don't let your money languish in a bad investment. Cut your losses and use that money to take advantage of other opportunities.

"How do I know when it's time to move on?" you ask. It's easier than you think. If it's a mutual fund, check your fund's performance figures against others in its group (for example, check your tax-free bond fund against other tax-free bond funds.) If your fund performs more than 20% below the average for two consecutive quarters, consider selling. If it's an individual stock you're concerned about, you know you've made a mistake if there's bad news about that specific company or the entire industry.

These reasons to sell may sound very basic and, to tell you the truth, they are. But you'd be amazed at the number of investors who skip the basics in search of more complicated strategies. That goes against one of the investment rules we live by: Don't make investing too difficult ... it doesn't have to be!
And, of course, don't forget Warren Buffet's mantra: Rule #1 is Don't Lose Money. Rule #2 is Don't Forget Rule #1!