Look at your stock portfolio as a business

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Retail investors often make mistakes due to their emotions. Successful companies rely on the management of great teams to navigate complex situations with a cold, emotionless perspective. Adopting this approach can be a winning strategy for investors. If you look at your portfolio as a business made up of different divisions rather than a basket of investments you will make better decisions.

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Management teams at great companies always seem to know what to do in any market. If they are consistently exceeding earnings targets, sales are up, the economy is booming, they take advantage by expanding. Using new capital to explore different avenues related to their business. Companies will hire new teams to develop new ideas aimed at expansion, or move to acquire smaller companies they believe will bolster their bottom line.

When the economy tightens up and earnings start to drop, good companies focus on their core business and trim unnecessary projects. Great companies explore how they can leverage this setback to their advantage and gain market share. They view tough situations as an opportunity to refine their business and make it more profitable.

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Investors follow the expansion strategy well in a bull market. As capital markets rise year over year, growth companies emerge with promising futures. Slowly but surely these growth stocks are added to portfolios with increasing weight. Stocks soar in value on high expectations as the market and economy continue to grow. Investors of all kinds have a habit of chasing gains. As a result, these growth companies can see their market cap take off until they are priced well beyond a perfect future.

As market sentiment turns negative, we see this strategy take a detour for investors. Market corrections should be viewed as necessary parts of the market cycle. Instead investors often perceive corrections as a direct threat to their long-term goals. This can cause worried investors to react with their most basic instincts: Fight or flight.

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Those that succumb to the fight response attempt to eliminate the threat by taking swift action. Mutual fund flows typically turn negative during market corrections, this suggests that investors are subscribing to a sell now, ask questions later strategy. The reasoning behind the move is that it will stop the threat of more losses. This ignores the reality that by selling to cash the investor has compromised their long-term goals which depend on market generated returns. For example, if you invested $100,000 in an S&P 500 index over the 10-year period ending on Dec. 31, 2021 your investment would be worth $462,575. If volatility drove you to sell the portfolio to cash and you missed the best 10 days in the market during that 10-year period, your portfolio would be worth $257,143 on Dec. 31, 2021. A difference of -$205,432.

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The individuals who react with a flight response attempt to avoid difficult decisions in their portfolios. In my experience, this behavior is more common among new capital market investors. Their portfolio that was relatively easy to manage, trending up and to the right during a bull market, is suddenly losing money. If they need to draw an income or want to reallocate capital, they make the decision that doesn’t sting and sell winning positions. This causes individuals to hold onto losing stocks when the opportunity for recovery and growth is long past its expiration date.This behavior is known as the disposition effect.

If instead the behavior was reversed, and money was salvaged from bad investments it could quickly be put to better use in stocks with a greater chance at helping the portfolio reach its long-term targets. Individuals that find themselves ignoring hard decisions would be wise to consider consulting with a capable adviser. The adviser can do all the manoeuvring necessary to focus the holdings on stocks poised to outperform.

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Corporate managers are not afraid of making tough decisions and moving on from a venture that a short while earlier seemed promising. Even if that means lay-offs and lost capital. Between 2007 and 2010, Ford Motor Company CEO Alan Mulaly exemplified this fearless behavior. The company sold Aston Martin, Jaguar, Land Rover and Volvo in order to survive the global financial crisis. Mulaly knew that sacrificing those brands would give them the cash needed to overhaul Ford’s core business and pivot to a lower-cost production model. Due to the timely, tough decisions made by Ford’s management team, the company was able to avoid taking a government bailout unlike their direct competitor General Motors.

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Understand that similar to a business, your long-term goals depend on the ability to make tough decisions, often in very trying times in the market.

In these moments if we could coldly examine our portfolios like a manager looking at the different parts of their business, very quickly we could separate the wheat from the chaff. Eliminate growth ideas whose outlook isn’t what it used to be. Focus instead on the core money makers that will provide stability and a good return on investment. Similar to a company focused on growing their market share while their competition is floundering, we can deploy new capital by investing savings and re-allocating capital to increase our share in the companies we believe will perform well over the long term.

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Cultivating the emotional distance required to invest well can be difficult, and this is where an adviser can help. Much like the manager of a business, an adviser can offer sound advice while maintaining emotional distance from the investments themselves. Keeping their focus on your long-term goals and the overall success of the portfolio.

Taylor Burns is a Chartered Investment Manager with Balanced Financial Wealth Management, an independent financial advisory firm. 

The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Incorporated.