To Sell or Not to Sell, That Is the Question
Most investors have to face loss aversion in their own investment portfolios when they incur losses. For long term investments the best course of action is to stay invested through the ups and downs of markets. But what if an investment is short term or has a limited investment horizon and the remaining time is shorter than the time needed to recover?
Imagine that an investor has bought a specific stock with the intention of holding it for three years. In the first year, due to a string of bad news or a general market downturn, the share price falls by 20 percent. In order to break even after three years, the stock needs to have an average return of 12.5 percent per year over the remaining two years or even higher if the investor wants to make a sizeable profit over the entire three-year holding period. In many cases, stocks that have declined significantly are unlikely to recover over a short time, yet most investors refuse to sell a stock with a 20 percent loss or more. Instead they tend to hold on to it, and what started out as a short-term investment is mentally turned into a "long-term investment.