In the villages of South India, hunters used a deceptively simple trap to catch mischievous monkeys. A gourd (like a coconut) is cut just narrow enough to fit a monkey’s hand. The hunters then place a piece of fruit inside. The monkey reaches in, clenches its fist to grab the fruit, and is stuck. The opening is designed to be wide enough to fit an open hand through, but not a clenched fist.

The gourd is in a makeshift cage or staked to the ground so it can’t be carried away. The only way for the monkey to escape is to unclench its fist and drop the fruit. But very often, it won’t.

Here’s where it gets interesting…

These crude traps aren’t in areas where food is scarce. Hunters would place them in areas with plenty of fruit. After all, that’s where the monkeys are.

Even though the monkey could easily escape by dropping the bait, even though there is plenty of food available, the animal chooses to be trapped.

Most investors probably like to think of themselves as clever hunters.

But in reality… they’re the monkeys.

Today, I’ll show you how not to be one of them.

What’s in Your Gourd?

Have you ever held on to a stock that you knew deep down was a lost cause? If we are honest, we’ve all fallen for this trap and held on to that gourd against all reason. You might even be doing it right now…

How about gambling precious capital into high-risk investments? Ever bought a sky-high dividend yield that seemed to be funded by magic? What about tech or meme stocks trading at 10 times sales with no profits in sight?

Many of us are guilty of putting too much into speculative assets like crypto without a plan to deal with the inevitable volatility. Now, there is nothing wrong with high-risk, high-reward opportunities. But that only works if the investor carefully studies and understands both sides of the trade. And changes course when the data changes.

More often than not, investors fall for the classic sunk cost fallacy.

“I’ve already invested $10,000 into this electric vehicle startup,” they might say. “Yes, it’s now bleeding cash and sinking in debt, but I’m already down 50%. Management can turn it around. I’ve invested too much time and energy to let go now.”

If you ever find yourself in that position, how are you any different than the monkeys?

The monkey is surrounded by other food. All it has to do is let go and get its meal elsewhere. But it won’t.

In the markets, there are tens of thousands of stocks and bonds to choose from all available on the menu at your brokerage account.

Don’t get me wrong. I’ve been there, too. I learned most of these lessons the hard way managing money for a long/short hedge fund during the Great Recession. It was a brutal class and every lesson on fear and greed was in the curriculum.

For most of us, admitting defeat and cutting our losses is extremely difficult. Humans would rather suffer a moderate amount every day for years than let go of the gourd and get it over with.

A Cautionary Tale

Everyone’s “gourd” is a little different, but there are ways to avoid the trap.

Ask yourself this: Would I buy this stock today?

Take an honest look at the big winners and losers in your portfolio once a quarter. In many cases, the answer is “no”. That’s a good sign to take some off the table… or finally cut your losses.

If the answer is “I’m not sure,” that’s when you know to do more research.

On a more tactical level, consider the fundamentals that led you to invest in the first place. For me, that’s often a combination of margins, earnings growth, and balance sheet quality.

If one or more of those variables starts to go south, I consider letting go. The reason this sounds simple but is deceptively effective is because of psychology. If I exit a position early by acting on my plan, it doesn’t feel like I “lost.” It’s just my plan working as it should.

Without a strategy to lean on, exiting a losing position feels like admitting defeat. It’s painful. And if you are human (or a monkey), you’ll hesitate. And the farther it goes down, the harder it is to let go.

But sometimes, you just have to unclench your fist.

There’s plenty of fruit to go around.

Regards,

Stephen Hester
Chief analyst, Wide Moat Research