Don't Dump On The Dogs

By Lisa Smith AAA

When investors look at their statements and see money-losing investments, or investments that have failed to beat their benchmarks, the first word that often comes to mind is "SELL!" Dumping those money losers has a strong psychological appeal: they're off of your books, you don't have to look at them or think about them ever again, and the remainder of your money is returned, so that you can (ideally) invest it in a winner. Sounds like a great plan, doesn't it? Maybe … and maybe not.

Take a Long Hard Look
Before deciding to sell, take a careful look at the investment. Is it really a dog, or it is a solid investment that just happens to be out of favor at this particular point in time? If you have a solid asset allocation strategy, your portfolio is likely to contain a variety of investments. After all, diversification is a well-known strategy for reducing risk and increasing returns in your portfolio. (To learn more, read Introduction To Diversification and The Importance Of Diversification.)

In a diversified portfolio, some investments will deliver better performances than others, and some will likely be below the benchmark. After all, everything can't beat the benchmark all the time. That doesn't necessarily mean that the poor performers are bad investments.

Reassess Your Assets
Consider your holdings from a strategic perspective. If your stocks are doing poorly during a time when the stock market is down, there's no need for panic. Instead of simply selling, think about why you bought those stocks in the first place. Do they still serve that purpose? If you bought a particular stock for its long-term growth potential, a down quarter or a down year doesn't automatically mean that it's time to sell - in fact, it may mean just the opposite. (Learn to use security selection as a way to minimize risk while maximizing return in Achieving Optimal Asset Allocation.)

Long-term investors understand and accept that the value of their investments won't always go up. Rather than buying and selling stocks in an ongoing effort to chase performance, they select investments carefully, choosing each one for a specific reason: to create a portfolio in which the whole is greater than the sum of its parts. For example, a small-cap growth stock may have been added to a portfolio in pursuit of alpha, but it's not going to deliver big results in a market dominated by large-cap value. That doesn't make it a bad investment. Likewise, blue chip stocks may lag when small caps are in favor. (To learn how selecting a mix of securities can be the core of your investing strategy, read Asset Allocation Strategies.)

When a Dog Is a Dog
While making a hasty decision to sell is not a good strategic plan, sometimes a dog is truly a dog. To decide if the stock you are thinking about selling really should be sold, you'll need to take a close look at the situation.

By looking at the balance sheet and reviewing a company's financial situation, as well as its standing against industry peers, you can make a sound judgment regarding its status. If your analysis reveals a company that has lost its luster and truly is a dog, you can pull the trigger and sell with no regrets. (For an easy-to-understand tutorial that provides an overview of the techniques for analyzing a company's financial statements and reports, see Introduction To Fundamental Analysis.)

Running With the Pack
Speaking of dogs, the dogs of the Dow is a famous and successful investment strategy that revolves around building a portfolio equally distributed among the 10 companies in the Dow Jones Industrial Average (DJIA) that have the highest dividend yield at the beginning of the year, then readjusting that portfolio on an annual basis to reflect any changes that have occurred to these 10 companies throughout the calendar year.

By buying these companies, you are essentially buying the cheapest stocks in the DJIA - companies that are temporarily out of favor with the market, but still remain relatively successful. Of course, the hope is that the true value of these bargain stocks will be realized, and you will be able to capture a tidy profit at the end of the year by selling them and buying the new "dogs." Some value managers live by this strategy. (To learn more, read Barking Up The Dogs Of The Dow Tree.)

Every Dog Has Its Day
Seeing underperforming stocks lounging around in your portfolio can certainly raise your hackles, but sometimes those (seemingly) lazy mutts are good dogs that just aren't having their day. Before you bark up the wrong tree with a decision to sell, spend some time sniffing around. You might find that you holdings have the right pedigree after all.

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