Chapter 15
Buy-Hold Myth #6: You Haven't Lost Any Money Unless You…

No, I didn't forget to finish the chapter title. I started it, but I want you to finish it. You've probably heard this statement a hundred times: “You haven't lost any money unless you ______.” If you're anything like my seminar attendees, you can finish the sentence without even thinking about it. When I ask this question, they shout out the answer right away: “You haven't lost any money unless you…sell.”

This buy-hold advice is brilliant in its simplicity: “You haven't lost any money unless you sell.” Do you want to lose money? Of course not. So you don't sell. You think you're safe that way. Until the day you look at your statement and see that you're down 50 percent, just like a certain garage mechanic…

Shame, Shame, Shame

Gomer's garage was going gangbusters. “Golly!” he said to his cousin Goober. “I think we're going to need another auto lift. I'm going to go downtown and take some money out of my account.”

A little while later, Gomer sat in his financial advisor's office.

“You probably know that the market is down quite a bit right now…” said his advisor.

“It is?”

“About 50 percent.”

“Golly!”

“But as you know, you haven't lost anything unless you sell.”

“Phew. I sure am glad I didn't sell,” said Gomer, “because I need some of that money right now.”

His advisor cleared his throat and handed Gomer a statement. “As I said, the market is down…”

“Sure is lucky we didn't sell, isn't it?…Hey! What's this?” Gomer asked, pointing at the minuses on his statement. “This says I have less money than I did before.”

“That's just a paper loss.”

“Good,” said Gomer, “let's go get my money.”

“It's not that simple. You see, your money isn't in your account…”

“Where is it? Are you keepin' it in a drawer back there?”

“No.”

“Do you mean I don't have that money anymore? You told me that if I didn't sell I wouldn't lose any money!” Gomer pointed a finger at his advisor. “I trusted you. Shame, shame, shame!”

I couldn't agree more. And I'm a little steamed. I have met so many people who lost so much money. I talked to one gentleman who lost $600,000 in 2008. He said he called his advisor nine times (nine!) and his advisor kept saying, “No, no, stay the course, don't do anything.” This investor said his advisor told him, word-for-word, “Don't worry. You haven't lost any money unless you sell.” “What do you mean?!” said the investor. “I haven't sold anything and I've lost $600,000!” He was outraged. He felt like he was being ridiculed. How could his advisor believe what he was saying when his client's portfolio was down more than half a million dollars?

“It's just a paper loss” really angers me. The whole idea insults my intelligence. What does that mean, “a paper loss”? What they want you to think is that you haven't lost any money. Not true. A paper loss is an actual loss. Like Gomer, if I want to take money out of my account, I can't take out the past or future value of my investments. That money is not in my account. It's only the current value I can draw on.

Mini-Myth: Future Appreciation

Some advisors hang their hats on “future appreciation.” Once you sell a stock, they argue, you can't take advantage of its inevitable upswing. If you ever hear this argument, I'd suggest you look around for your advisor's crystal ball. How can he promise there will be future appreciation? What if there isn't? What if your stock keeps going down? There are no guarantees. Remember the employees of Enron? At the end they were actually locked out of their accounts. They couldn't sell even if they wanted to. Did they lose money? Yes, they did. They lost everything.

The idea of future appreciation is tied to “the market will come back” myth. As we discussed in Chapter 11, no one can predict the future market. It may come back. It may not. It may come back, but take 25 years to do so, as it did after the Great Depression. And whether the market does or doesn't bounce back has nothing to do with whether you lost money. Those are apples and oranges. If someone combines those two ideas in one sentence—“You haven't lost any money because the market will come back”—they are saying they can predict the market. And in my opinion, if they tell you that you haven't lost any money unless you sell, they are lying to you. I contend that the opposite is true: The way to not lose money in a bear market is to SELL. The only way to not lose money in a bear market is to not be in it. To do that, you have to sell.

A Flat-Out Lie

I know that “lying” is a strong word. In my view, though, if your account statement says you're down, you have lost money. Whether you have sold or not is irrelevant. If you look at your statement and there is a loss, you lost money. Period, end of sentence. Anyone who tells you differently is lying.

Some people tell you that you've only lost money if you sell so that you'll be afraid to get out of the market. Why would they want you to be afraid? Because if you sell, they stop making money.

Why They Don't Want You to Sell

Many investment houses benefit from investors staying in the market. If you are sitting in cash for a year, they are not making any money. Other advisors receive 12B-1 fees, which are ongoing fees based on investors' use of a mutual fund. If your advisor works on that fee structure, and you sell and go into the money market, your advisor gets no income. Effectively, by telling you to sell, your advisor has told you to stop paying him.

These firms and their advisors have a vested interest in convincing you to stay in the market. Imagine if they were paid for selling, rather than buy-holding. I think they'd sing a very different tune. I think they'd say, “You're losing money? Sell! Sell! Sell!”

I'm certainly not saying that all financial advisors are self-serving. Most want the best for their clients. I do think it is human nature, though, to convert a benefit to one's self into a benefit for others. No matter how honest they are, or how high their integrity, financial planners are swayed in the direction of the product or service or action that will make them the most money. They find ways to convince themselves that what is good for them is good for their customers. They may truly believe that the market will come back, and that their clients' money will come back, too. That doesn't mean they're right. In fact, one study found that mutual-fund managers who held onto losing stocks fared worse than managers who cut their losses—by about four percentage points annually.

You want an advisor who is willing to cut losses when necessary, one who has no vested interest in whether you are invested in one product versus another, or in any investment versus cash. To make sure there is no conflict of interest, you need to understand how your financial planner gets paid. Ask your advisor (or prospective advisor) straight out, “Will you ever put me in cash?” If the answer is, “I will never put you in cash because I believe you should always be invested,” you have your answer. If your advisor says, “Yes, I would get you out of the market if necessary,” ask, “What happens to your income if I'm in cash?” If you learn that your advisor will not get paid if you are out of the market, you'll know that advisor will have a very hard time putting you in cash during bad times. It probably won't happen.

Why You Fear Selling

Behavioral-finance professor Terrance Odean of the University of California, Berkeley, has studied the behavior of investors who are reluctant to sell. Based on his research, he believes that the issue “isn't primarily about economic loss, it's about emotional loss.” Investors, Odean thinks, want to believe that their original stock-buying decisions were good ones. Once they have to sell that stock below its purchase price, they can no longer tell themselves that they made a smart choice.

In my experience, people who feel they made bad choices suffer more than people who feel they missed out on opportunities. Let's use an example: Two people both have $100 to invest. One of them sits on the sidelines and misses out on a 25 percent rise in the market. The other person invests that $100 and, oops, the market goes down by 25 percent. Both of them lost $25—one by missing out on an opportunity, the other by losing money in the market. Which person do you think felt worse about their decision and its end result? I think most people feel the loss of actual money much more keenly than the loss of a potential gain, even when the dollar amount is the same.

It also appears that people feel the pain of losing more than the pleasure of winning. In an unpublished study led by Gregory Berns of Emory University, researchers studied the brains of people who were asked to hold or sell an investment. The researchers used a brain scanner to focus on an area of the brain known as the ventral striatum, which typically responds to rewards. They moved the prices of the participants' assets up and down, and watched their response. Interestingly, the subjects' reward centers did not show significant activity when a stock price rose. When the study participants were questioned later, many said they had hoped for a rise. The research suggests that the test subjects weren't surprised by their stocks gaining value and didn't feel rewarded, because the rises and rebounds in their asset prices were anticipated.

I've noticed this phenomenon. When stocks go up, people tend to think, “I knew that stock would go up. Boy, I'm smart!” There's not a big emotional reaction. They see the rise in their asset prices as a validation of their intelligence and good decision making. But when their investments go down, they feel it in a personal way. They feel like they made a bad choice, like they're not as smart as they thought they were.

When we're on top of the world, we think we're great. When things aren't working out for us, we think we stink. There is a quote from Rudyard Kipling above the gates at Wimbledon: “If you can meet with triumph and disaster and treat those two impostors just the same” The wise person realizes that triumph and disaster are impostors and doesn't get swept away by either one, but it's tough to do. It goes against our nature.

Not only is it human nature to want to validate our choices, but our brains are geared to look for patterns. This behavior evolved to help keep us safe. “My friend was eaten by a saber-toothed tiger,” thought the caveman. “That guy who lived in the cave over the hill was also eaten by a saber-toothed tiger. The next time I see a saber-toothed tiger, I'm going to run.” Though this sort of thinking may have saved us from being eaten by tigers, it can work against us. We sometimes latch onto patterns we think we see in the marketplace and think that the patterns repeat themselves exactly. Of course they don't, which is why nobody can predict the market. The market's ups and downs are often random. And even though random can happen three times in a row, it's still random. Ascribing certainty to a random event is not the wisest thing to do, but we were made that way for self-preservation purposes.

Our belief in patterns also helps convince us that our current situation will continue. Back in the late 1990s, during the great run-up of the tech bubble, the market was rising by 20 percent a year. I remember clients who would comb through their portfolios and say, “Anything not making at least 15 percent is a dog and I want to get rid of it.” They had become accustomed to that particular market and thought it was going to go on forever. People feel the same way about bear markets: Whatever the current circumstance, that's the one people think will continue indefinitely.

When it comes to investing, you can see that our brains may work against us in several ways:

We believe that our investments will go up.
We feel like failures when our stocks go down.
We look for patterns, and rely on them to tell us how to act.
We believe that our current circumstances will continue indefinitely.

Add to that that the fact that we are wired to avoid pain, and you can see why we find it so difficult to sell, even when it's the right thing to do.

Buying Stuff Is Fun

We do like to buy. As investors, we are conditioned to buy. We've been trained over years and years to work and save so we can invest, or, in other words, so we can buy. I believe this conditioning makes most investors brave when they buy and scared when they sell. And I believe that they'd be much better off if they could be the opposite.

I'm not saying you shouldn't buy, but that you should think carefully when you do. You should be a coward when it comes to buying. It is after you have bought an investment that you could lose money. That is where your risk lies.

But when you sell an investment, you get to keep what you have. You know the price you sold at and the amount that will end up in your account after you have sold. You have now eliminated all the risk in that investment because you do not own it anymore. I contend that the advisor who says, “You haven't lost any money unless you sell” has it backwards. As mentioned earlier, the way to protect yourself from loss when the market is going down is, in fact, to sell. Do it bravely.

Live to Fight Another Day

Being a brave seller isn't easy, especially if you've been a buy-holder. I know people who have never sold anything in their lives. How stressful would it be to suddenly change a strategy you've followed for 30 years? To get out of the market when all of your buddies are telling you to stick it out? To sell when your advisor tells you that you haven't lost anything unless you sell?

It can take courage to sell. You may not get back your original investment. But sometimes you have to cut your losses. A good general won't leave all his forces to fight an uphill battle. He won't sacrifice his troops when there's no hope of success. He will pull them back so that they will live to fight another day. He knows that winning the war is more important than victory in any one battle. As investors, we have to distinguish the battle from the war, and make sure we don't deplete our resources to the point where we don't have enough capital to continue the fight.

You can always get back in the fight later. Remember the nonsensical arguments about missing out on future appreciation and the market rebound? Those arguments imply that your stocks will come back and you'll miss out on great opportunities. But there is no law that says that if you sell, you can't buy back later. You're not prohibited from buying back your investments. If you sold a good asset because you couldn't afford any more loss, you can always buy it back, maybe even at a lower price.

By getting out of the battle and protecting your principal, you can make sure you have the means to buy back your investments. Yes, you may have missed out on potential gains, but you lived to fight another day. If you buy into the idea that “you won't lose any money unless you sell,” you may feel okay about your investments until it's too late. You may avoid the pain of selling, but leave your principal at risk. You may feel fine, but you're living in denial. And living in denial can make you poor.

The Real Answer

“You haven't lost any money unless you sell” is advice that is meant to keep you in denial and in the market. Not only is this particular advice a myth, it's a flat-out lie. The truthful way to state that sentence? “You haven't lost any money if your statement shows no loss.” The mere act of selling is irrelevant.