They say it takes a few weeks to a few months to form a new habit. But I think it takes even longer to quit one.
Just ask any smoker, alcoholic, or addict. Or any Starbucks junkie, for that matter.
For my part, I have a history of refusing to quit business ventures even when it’s clear I should.
As my regular readers are aware, I was a real estate developer for over two decades… much of which involved me partnering with someone I never should have gotten in business with in the first place. Yet I stayed there day after day, month after month, and year after year.
I had helped build that company, after all. Did I really want to give up on it? Didn’t I owe it to myself to press on despite the rising challenges? Wasn’t quitting an act of weakness?
I used to think that way. Then I started reading Annie Duke’s Quit.
It was eye-opening for me. And, for investors, I think the lessons could be useful.
Know When to Fold ‘Em
Annie Duke used to be one of the world’s top poker players. And I’m sure she could still clean most of us out if we sat down with her today.
But she has shifted her focus in recent years to write, coach, and speak on beating the game of life instead. Sometimes, she says, that means knowing when to fold ’em – even when we’re heavily invested.
When we own something, we value it more than an identical item that we do not own. Richard Thaler was the first to name this cognitive illusion, calling it “the endowment effect,” in which he coined the term “sunk cost.”
He described the endowment effect as “the fact that people often demand more to give up an object than they would be willing to pay to acquire it.”
That’s because “losing feels about two times as bad to us as winning feels good to us.” Therefore, “when you already own [a] stock and the price has declined since you bought it,” you’re “more likely to hold onto it, trying to win back what you’ve already lost in the position.”
The result of following this mindset can be painful or even devastating losses. So, it’s crucial to know how to break free. Duke – who says that professional poker players actually quit much more often than amateurs – writes:
The best quitting strategy would be to examine all of your holdings, not just the ones at the tails of your portfolio, and decide which are going to generate the least value going forward and sell those.
Then, she advises, you can create a sell-side shadow book.
Now, the standard definition of a shadow book is a record of assets an investor wanted to buy… but didn’t. That way, they can track how well or how poorly it would have gone and adjust their thinking accordingly for actual purchases.
In the same way, Duke suggests investors “create a book that tracks” the sells they make. “See how they’re doing compared to a benchmark of how they would have done if [you] randomly sold something different in the portfolio at the same time.”
If done right, you can use that comparison as a reminder the next time you want to keep hold of some investment you know deep down inside you shouldn’t.
When Quitting Is the Best Choice You Can Make
Here at Wide Moat Research, we employ stop losses to combat “the endowment effect.” This means that, before we even buy a stock, we commit to selling it under certain circumstances.
If it drops, say, 20% below our open price, then we part ways. No questions asked. No ifs, ands, or buts about it.
I can’t say I’m always happy with that policy. (Again, I don’t like to quit.) But it has saved us from suffering an even greater drop on several occasions. For instance:
-
We had to sell Constellation Brands (STZ) at $165… and now it’s down to $135.
-
We had to sell Alexandria Real Estate Equities (ARE) at $94.47… and now it’s down to $86.
-
We had to sell United Parcel Service (UPS) at $111.77… and now it’s down to $84.
-
There were other times when we quit a stock without being forced to…
In October, we recommended readers of The Wide Moat Letter sell their position with Nike (NKE) for about a 6.5% loss. That’s never fun. But as Nick Ward explained at the time:
For the last year or so, Nike has been undergoing structural changes, refocusing on its products and technological innovations rather than the direct-to-consumer distribution model that Donahoe put into place in an attempt to raise margins. We thought that Hill was going to be the man for the job, so to speak, with regard to finishing the restructuring process.
However, the fact that Nike just pulled full-year guidance scares us.
That’s not a word that we use lightly. Both Brad and I understand that investors should not let fear (or greed, for that matter) drive their decision-making in the market. Yet, without clear guidance moving forward, it becomes very difficult to evaluate the company.
When we recommended quitting Nike, shares traded for around $80. The stock would fall as low as $52 by April. And even after its recent rally, shares are hanging around $71, about 11% lower than where we cut them loose.
Those are significant differences that I’m obviously happy we didn’t have to experience first-hand. Yet in the moment, it really didn’t feel good to let go.
That’s human nature for you.
Fortunately, human nature is capable of changing, of acknowledging how, to quote Duke again, “the sooner you figure out that you should walk away, the sooner you can switch to something better.”
Since that’s my entire goal here at Wide Moat Research… one that’s shared by every single one of my team members… I plan on devoting a few more articles to the topic of quitting going forward.
I’ve personally seen the destructive results of not quitting. And if you invested through the dot-com bubble, the housing market crash, or the 2020 shutdowns, you might have your own stories to tell.
Quitting is never fun… or easy. But sometimes, when the odds are stacked against you, the best move is not to play.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Wide Moat Daily
P.S. Make sure to visit my YouTube show this Thursday. Nick Ward and I will be revealing six of our SWAN stocks that are easy to hold onto because they rarely give you grief.
|