When Price Doesn't Matter
I occasionally view things differently than my wife, for which I take full responsibility and repent the error of my ways. For example, I do not fully appreciate a good bargain. When my wife buys an item for $50 that was originally $300, I do not share her enthusiasm, although I express my pleasure at her good fortune. To me, either the item was worth $50 or it wasn't -- it's previous price is irrelevant.
With investments, the purchase price can get in your way of clear analysis. Let's say you bought the XYZ stock a few months ago for $100 per share and it now trades at $70. Should you sell it? Well, there are numerous factors that go into such a decision. Does it make a difference that you bought the stock for $100 per share? Absolutely not!
Putting aside tax considerations, the only price that matters is the current one. You need to determine whether the XYZ stock remains a good investment going forward at $70 per share or whether your money would be better invested someplace else.
The original purchase price simply clouds our thinking about the future. The prospects of the XYZ stock today has nothing to do with what we bought it for in the past. We hate to admit that we purchased a loser. Many investors say to themselves: "I'll wait until the stock recovers to $100 before I'll sell it." Yet, the XYZ stock may never get back to $100 per share or it may take decades to do so. Why hang on to an unattractive stock when better investments may exist?
This means that you are ultimately "buying" the XYZ stock every day you hold it. By retaining the XYZ stock, you are saying that it is a good value at its current price relative to its future prospects and that there are not other, more attractive, alternatives available. While institutional money managers may think like this, the average investor likely finds this daily process of analysis too overwhelming. That doesn't mean, however, that the concept is not worth considering.
Words of Wisdom
My wife will buy anything marked down. Last year she bought an escalator.
-- Henny Youngman
[Editor's Note: Henny Youngman is from a different era and we in no way endorse any sexism in his quote.]