IT WILL COME BACK…
“It will come back” is a phrase I have heard many times during my 21+ years as a Wealth Manager. I am referring to people who own a stock that has fallen substantially in value and they don’t want to sell it. But will it really come back? And what is the cost of waiting for it to come back?
One of the many interesting things I find about being a Wealth Manager is dealing with human psychology. It is very hard to get people to buy when the stock market is crashing and extremely easy to get people to buy when they see high returns (which is quite the opposite of what should be done). Also, I have found that investors seem to sell their ‘winners’ early so they can cash in on gains and say they made a profit, but sit on their ‘losers’ in hopes they will eventually come back. I have read a few books that talk about this in more detail and this behavior has spawned a whole new field of study known as “Behavioral Finance”. This field of study analyzes investor behavior and what motivates people to invest, buy, or sell. A simple search on Amazon for the topic will yield over 2,000 results, but I am focusing here on my real-life experience in working with people.
I went through the 2000-2003 stock market crash with my clients and it was extremely humbling. I thought in 1998 and 1999, while working in the Silicon Valley, that all my clients were going to be multi-millionaires working for technology companies within the next 5-10 years as I was easily generating 25%+ rates of return (and thought it was easy to do so). I saw many people fall into the ‘it will come back’ trap during 2000-2003 as they doubled down and invested more into their tech stocks and continued to exercise and hold stock options. I recall one conversation with a gentleman who had worked at Cisco Systems for only a few years and had millions in vesting incentive stock options. I tried to convince him to sell a huge chunk in 2000, but he refused and said it was only going to come back up and he invested more into the stock purchase plan and continued to exercise and hold his options (he wanted to hold the stock for 12 months to capture long term capital gains tax rates). The end result was he had a tremendous tax bill from all the option exercises and ended up with stock worth less than what he owed in taxes a year later!!
You might be reading this and think that the tech boom was an extreme, so let me use a more recent example. I had a prospective client earlier this year share their portfolio invested with another advisor. She pointed out certain companies to me and said, “I’m not sure about holding these stocks, but my advisor said they will come back.” She was referencing several companies involved in the oil and gas business. She was very astute and noted how her other holdings were going up substantially with the rising market, but the oil and gas stocks were all negative and some were even continuing to trend downward. She may not have known it, but she was telling me that she was aware of the “Opportunity Cost” of continuing to hold her losers. The cost of sitting in a stock that is doing nothing when it could be invested and rising in value someplace else. She said she had bought them on the suggestion of her advisor several years ago when the price of oil fell and he said it would come back again and it was a good time to buy. Based on her words, her previous advisor basically said that she should simply buy these stocks because the price fell and they will come back because oil prices will go up again someday. But here we were looking at cash losses well into the 5 digits for her ‘cheap’ stocks that should have gone back up while her other stocks had made very large gains.
The problem is that investors don’t look closely enough at why a stock fell and what it would take to get back to where it was. Cisco Systems is a great example. Here is a chart from Yahoo! Finance that shows what would have happened if you had purchased and held Cisco stock right around the big run up in 1999.
As you can see, Cisco Systems hit a peak of almost $80 per share in early 2000. I know many people that bought on the first dip only to watch it fall down to below $20. By the end of 2007, the stock was trading at $27.07 per share. Cisco may eventually get back up to almost $80 per share, but let’s add an overlay of the “Opportunity Cost” and increase the timeframe. Let’s say you bought Cisco in January of 1999 and held it versus putting money into a simple Vanguard S&P 500 Index Fund:
As you can clearly see, the hypothetical investor would be waiting for Cisco to recover 13 years later versus cutting losses and investing elsewhere for a profit. Cisco was simply bid up too high during the tech boom and investor expectations for the growth of Cisco were unrealistic. Cisco did not recover and go back up because the reason they went down was valid as there was no reason the stock price should have been that high in the first place!
In the case of oil stocks, between oil production increasing steadily and the emphasis on renewable energy, there is a glut of oil in the world marketplace. Along with slowing growth out of China, I don’t see oil stocks ‘coming back’ anytime soon and a quick look at profits verifies that. However, things always change and I may suggest oil stocks in the future, but I feel right now the Opportunity Cost is too high and there are better places to invest.
In the end, the prospective client I mentioned earlier decided to move everything to my management, we sold the oil stocks (which trended downward since we sold them), and I have her invested in stocks that have been going up with this rising market.
So the next time you think to yourself, “it will come back”, analyze why it came down, look at the companies financial statistics (or ask a qualified advisor), and then decide if you should keep it. Keep in mind if a stock fell 50% in value that it will have to earn 100% to get back to its starting point! Don’t let accepting a loss stop you from putting your money elsewhere because that choice just might make your money grow quicker!Google+