Stop or Go?

Sometimes I was asked these questions, ‘Should I switch funds? The fund is making a loss, should i surrender? Or should I keep and wait for it to rebound? This usually happens when a portfolio has fallen probably drastically (for the moment). This raises an interesting question: Should we employ stop-loss when we invest?

Why investors think of these questions is generally because nobody knows what is going to happen, and therefore they need to build in a circuit-breaker to avoid the behavioural basis that come with a loss-making position.

Fundamentally in a diversified allocation, or a diversified equity portfolio, it is more likely to rise over a given period of time than any individual stock. Reason being different asset classes have different drivers and hence are usually uncorrelated in their moves. Just combining them into a portfolio smooths out the bumps and increases the probability of positive returns for the portfolio as a whole. Therefore, the broader the investment, the less likely a stop-loss is warranted and a buy-low approach makes sense, especially when held by long-term investors.

In addition, portfolio rebalancing is done by fund managers, either regularly or after major market dislocations to bring their allocation back to their desired risk tolerance. In conclusion, for long-term investors, the stop-loss approach is likely to get in the way of wealth accumulation.