During World War II, Winston Churchill gave many rousing speeches to the English people as they were fighting in the air, land and sea. If you ever have the chance to watch Gary Oldman's portrayal of the Bulldog, I highly recommend it. Perhaps you've been told of Winston Churchill's commencement address where he stood up and said, "Never give up, never give up, never give up" and sat down.
The only problem is that he never actually gave that speech. It's part of the lore of Winston Churchill much like surrounds many people of strong character and historical significance. And it's actually not great advice. Now before you cast judgment and call me "quitter," I implore you read this blog entry to it's bitter end. Ironically, I'm asking you to not give up on this blog entry.
Cutting Your Losses
Retreat and reorganization is not the same as surrender. In World War II, there were many times when it made sense to make a tactical move to retreat. Think of the evacauation of over 300,000 Allied troops from the shores of Dunkirk (Another great movie, by the way). This was not an act of surrender, but a tactical decision to retreat and reinvest resources. Let me give you a personal example with slightly less historical significance.
In my closet, I've got a Brazilian Ju-Jitsu gi. Picture white, Japanese pajamas with Brazilian words on it. You see I used to go and "roll" around with a black belt instructor. I remember one day where I was paired with an older guy who weighed maybe 145 soaking wet to my 205 pounds of blue steel. Of course, he totally rag-dolled me and twisted me in any direction he deemed appropriate. Picture a python squeezing a pretzel. Unfortunately, I was the pretzel. At one point, just before losing consciousness from a rear naked choke, I tapped out. I quit. I cried Uncle. Better to live to fight another day.
The reason my gi is in my closet is because I tapped out of Brazilian Ju-Jitsu altogether. I just stopped going one week and never went back. It was well thought out, however. I realized that to get to the next level I would have to dedicate more time both in class and out. As I surveyed my life goals I realized that I was most likely not going to be the welterweight champ of the UFC. In fact, I probably wasn't going to make it into the UFC. In fact, I probably wasn't going to make it to welterweight. My time would be better spent as an armchair expert, a spectator. I freed up my time and redoubled on other goals, vocational and avocational.
A Hunk of Sunken Cost
When investing your time, talent and treasure, there's a human tendency to stick with a loser. Actually, it's got a name: sunken cost fallacy. The reason that we can’t see our own logical failure is because we are not logical. We pride ourselves as being rational investors; basing our decisions on risk vs reward and the future value of our decisions. In reality, we are emotional humans using impure reason to justify our past decisions. We don’t like to be wrong.
When it comes to wealth management, particularly investment management, it's okay to cut your losses. There's a saying actually, "Cut your losses and let your winners run." The idea is that when you invest you are going to be wrong. Your allocation may be too aggressive or not aggressive enough. Your timing may be great or horrible. The key is to not fall in love with any of your assets. Someone once said, the love of money is the root of all evil, after all.
Lose a Battle to Win the War
So how can you uncover and overcome the temptation of sunken cost fallacy. Let me offer three tips:
- Hire a fiduciary. As emotional beings, there's a benefit in a multitude of counselors. Having a financial advisor helps provide one more layer of emotional detachment from your past decisions. Keep in mind your current advisor is also an emotional being and may succumb to sticking with a loser as well.
- Have a tactical strategy beforehand. The reason your advisor wants to know your risk tolerance is so that they know what level of volatility will be too much. Typically, your advisor will set up an allocation that historically matches your temperament. Other than rebalancing periodically, it's a buy and hold strategy. However, this strategic strategy can also be supplemented with a tactical strategy. For our clients, that means we use technical indicators to create mechanical, repeatable rules for when to hold on to our allocations and when to cut our losses.
- Start with why. It's not enough to know what and how much you own. You have to know why you own it. Each asset class provides a level of diversification to offset another's characteristics. And I'm not just talking about volatility. That's only one factor. Consider the liquidity, fee structure and growth or yield potential of each asset in your portfolio. This is not just what you own, but why you own it. That way when your dividend stocks in your non-qualified portfolio underperforms your growth stocks in your qualified portfolio you don't panic. You own them for different reasons and require different things from them.
These three steps can be a bit overwhelming at first, so if you'd like some help, click here.