WHEN DO YOU MAKE PROFITS / LOSSES ?

[whiteheron]

I would like to know the opinions of other ShareTrader contributors as to when they consider profits or losses are made on shareholdings
To be specific , are they made progressively as share prices rise above or fall below purchase price or are they made only when the shares are sold and the money has been received ?

I have my opinion on this but I would not like to sway the opinions of others at this stage so will leave stating my opinion until after everyone has had a fair go at stating their views

I have no doubt that a variety of replies will ensue , that is if anybody is interested

[Halebop]

I essentially keep two sets of books. I track the current value of my investments as a broad measure of net worth (this is not 100% accurate as I don't record potential taxation liability on trades).

Then for taxation purposes I record book value as trading profits are not taxed until a sale is effected. This really only gets compiled approaching tax time though.

[Packersoldkidney]

Sold, definitely sold. The money isn't money till its in your mitts. And it aint a loss until you sell the dog you bought into and who wrought the unhappy experience of lost cash upon your bank account or wallet.

[Revhead]

Agree with POK. The outcome of the trade is determined when the stock is sold! The fact that the price may have been much higher the week before you sold is irrelevant. It's what you get in the bank that counts.

Rev

[Snow Leopard]

I am in the progressive camp. As the price changes your profit or loss changes. The day you sell is the day you realise same.

[KJ]

I treat short term trades and LT portfolio differently.

Short term-as on average I hold these for less than 2 mths & I record profits or losses when sold.

With my LT portfolio I take the progressive approach.This is better because I may hold some of these for several yrs.If I didn't do it this way and used cost, I would be looking at a misleading picture eg I would have values like-TPW $2.12,HBY $3.80 etc.
It also allows you to know how you are going on a PA basis.

[Phaedrus]

I would assume that everyone regularly marks their portfolio to market. This is the only sensible way of tracking your performance. Personal preference and trading style will dictate whether you do this hourly, annually, or something in-between.

I do not subscribe to the view that profits and losses somehow only become "real" when you sell. This absurd belief was summed up by LMFM when (in a PPG thread) he wrote "You only lose when you sell for less than you brought and you not losing if you holding."

My response was :-
"Paper" losses are, unfortunately, only too real. You HAVE made a loss and whether you choose to crystalise it at any point is immaterial. It is interesting to note that you make the same error of logic regarding profits when you say "you not making money unless you are selling". Nonsense. Anyone that has been holding a steadily appreciating stock for many years has made a lot of money - whether they sell or not. You have made a lot of money on your house - right? It would be silly to pretend that you had made nothing unless you actually sold it. The value is there and can easily be turned into cash at any time by selling at the market rate - just like stocks.

[zyreon]

mmm, when you purchase a share that is a sunk cost. You can not get it back. You can only get what someone is bidding.

[duncan macgregor]

I consider profits and losses at that moment in time at the buyers price. If i sell its confirmed, if i hold then its an on going investment. The tax only gets paid on the sale if taxable but to keep track its the price of the moment that counts macdunk

[Westie]

quote:This absurd belief was summed up by LMFM when (in a PPG thread) he wrote "You only lose when you sell for less than you brought and you not losing if you holding."


As an adjunct to Phadreus' comment, and for the sake of useless trivia, psychologists call this type of thinking a "loss aversion bias" (being somewhat acquainted with the field). It arises from people weighing up losses more heavily than gains. Having this belief tends to lead to people making irrational sell/retention decisions, eventually selling winners and holding onto underperformers, "cutting the flowers and watering the weeds" in Peter Lynch's words.

So while it is probably good for ones psychological health to delude oneself with this belief, it isn't particularly good for ones finanical health:)

[Halebop]

...and the mind and spirit quickly recovers when you swap from a bad'un to a winner.

How is cost relevant if the share price has since halved or gone up ten fold? The point of a roadmap is to look at where you are and where you are going - not where you were back in 1996. This is the crux of any form of benchmarking - it needs to be relevant and timely. Cost doesn't achieve this. Even the staid world of accouting recognises this with impairment transactions and the like.

How often do we read arguments here like... "I don't care what the share price is doing now - I earn a 12% gross yield on my original buy-in!". Now I'm not talking about minor swings and movements on a daily basis but why stick with something that is obviously falling just because you bought cheaply? Looking at cost does not support a healthy process of analysis, particularly in terms of "cutting the weeds".

[limegreen]

quote:psychologists call this type of thinking a "loss aversion bias"

psychologists also have a name for "averaging down". It's called the "sunk cost effect". That is, having put time/effort/money into an enterprise, people will continue to invest more so that the value of their initial input isn't "lost" or "wasted".

[Westie]

From what i gather, averaging down is considered irrational when it is premised on the basis of past costs, ie trying to recoup the original $ outlayed or focusing on the buy in price (termed anchoring) and believing the share must one day attain this again because it had in the past.

It isn't maladaptive when it is premised on a current cost/benefit analysis without regard to past cost.

[limegreen]

quote: It isn't maladaptive when it is premised on a current cost/benefit analysis without regard to past cost.

I'm not sure that's the same thing as averaging down. What you're suggesting there is treating it like a fresh buy without regard to your previous holding. Frankly, I'd also suggest that to the extent that the current cost/benefit analysis is similar to the cost/benefit analysis that lead you to make the original purchase, it's still sunk cost effect. I.e., you're still tied to your original analysis. If there are qualitatively different new parts to the cost/benefit analysis then perhaps it's a different story.

[whiteheron]

Thanks for the contributions so far
Any further comments before we wrap it up ?

I will try to summarise the responses and make comment in the next day or so

[zyreon]

losses are easy to mentally dissociate from when you have multiple holdings.

which can be an argument for focus investing strategies, or diversified buy and hold strategies

[Halebop]

quote:Originally posted by zyreon

losses are easy to mentally dissociate from when you have multiple holdings.

which can be an argument for focus investing strategies, or diversified buy and hold strategies


The best form of "mental disassociation" would surely be to avoid losing money? If you stick to your systems and ruthlessly sell the bad ones there is no need for diversification.

Perhaps buy and hold strategies (and cost price methodologies) work because people look at their 138% ten year gain as confirmation of their buy-in while conveniently ignoring the more recent 25% loss that took the shine off the results.

[duncan macgregor]

It is human nature to disregard losses, and only speak of profits. I really do not think the number of shares in a portfolio is all that important as the ammount of due diligence in buying them is all to important. What really is important after that, is your objectivity to the shares you hold, and the system in place to let you know to get out regardless of how right you feel. The very worst mistake is to think you are right, and the market is wrong. it is the market that says who is right and who is wrong, and the market dictates the price not you. The more companies you hold the less one result will be of concern, and the more likely to mediocracy your performance. Your performance can be measured at any given time by the buy prices of your portfolio. What i learned from other posters, and observations is that selling and knowing when to get out is equally as important as buying. Fundamentalists place all their thoughts and knowledge into buying, but are sitting ducks at the other end. The market along with everything else is in constant change, be prepared to change with it . macdunk

[robbo]

Great Topic Header White Herron.

Very applicable & real issue & TOPIC; for all of us. I'm sure we all agree...

Personal approach/philosophy is to spend a heap of independent Research, Balance Sheet analysis and Valuation BEFORE entering any position and cost benefit, ie: SWOT (Strengths, Weaknesses, Opportuinites and Threats), and try to ascertain the True Downside first, before, yes def. before looking for the Upside. So hre I'm trying to assess the true Margin of Safety.

So the time spent before the PURCHASE needs to be, for me, Is suspect MORE than most...

Of course that precludes me from Getting in on a Wave...say like a Palladin or Summit, coz I must intrinsically be able to sleep and relax and be non nervous and not suffer from "Buyers Remorse: the next day....

So I try and Devil Advocate with someone too before Buying...and get rid, of the Buyers Remorse possibilty....and the more experienced I get, the more this theme becomes even more re-inforced. (Two) concepts from Buffett here, again only what works for me personally....which are, for myself quite helpful & applicable,

(1`) Buying a stock is like getting married, you really don't want to go thru the hassle too many unnecessary times....

(2) Avoid cigar butt investing trying to get one more puff, from your durry,

(3) If you cannot be COOL [8D][8D] and calmly watch your stock drop 50%, "....then it don't mean a thing,.... coz you aint, .... got that swing...."...Buffett reckons that a drop of 50 % is totally cool if the intrinsics are cool, are I agree with him...

(4) Aim for 35% Gain every seven months...(2 reporting periods) compound...get out a calculator and do the maths,from any Capital sum above say $25, 000...soon starts to build up !!

(5) So I think there is a bit of a Danger in 10 bagger Hunting personally...coz more risk...what ultimately I want is consistent every 7 month, periood on period on period COMPOUNDING...returns...

(6) Also, personally, I like the mathematical statistical analysis of Buffetologyl from the "mathematically based statistical probabaility school" here...

eg: Typical hypothetical situation: Say you have a stock XYZ that goes up from say 40 cents to say 70 cents, thus in 3 months, we have on paper a 75% capital gain,which if we sell we can realize.....THE OBVIOUS GAIN

However we, feel, based on our analysis the the stock in question, will rise overall another say 120% -145%; in the next 12 -18 months or so..... and we can, right at the PRESENT time see that now our Stock XYZ: is 70 cents; that profit takers see, that it may fall temporarilly and we even may see our Stock XYZ fall back to say approx as low as even # 58-60 cents, before resuming an upward trend again.

So we are faced with a fear, and a REAL dilemna. What should we do ????? Join the Profit takers, or stay on-board for the ride ??

Of course what we all think we can do, is have our cake and eat it too...thus take the profit and buy back in at 60 cents...

And this, for me at least, IS where the Statistical analysis kicks in...

First I need to go back to First Principles: ie: achieving 35 % or beeter compounding per each consecutive seven month period aprox.

Second look at he probabilities that open up to endanger that goal if I take profits....

(a) Danger of not beeing able to get back in at 60 cents....ie timing the market... (b) might only be able to get part of my stock back at 60 cents.... (c) Pre-open//or new posiitve annnouncment out of trading hours,.... may happen again precluding re-entering stock XYZ advantageously (d) Got to stay glued to the screen, which is not cool IMO...(e) May be tempted to play with another "stock play with intention of going short"...with your capital and gains from Stock XYZ sell proceeds &gains...putting a whole new set

[whiteheron]

Hi folks , sorry I have been a bit long winded getting back to the summing up on this

Just to recap the question was " are profits and losses on shareholdings made progressively as share prices rise above or fall below purchase price or are they made only when the shares are sold and the money has been received " ?

I have endeavoured to classify the answers but the content of some of them has made this difficult
This is my best shot ;
Made progressively = 10
Made on sale = 2
Unable to classify = 5

Much of what I was going to say has been very aptly put by other posters and I thank you for your input

I am firmly with those that believe that profits and losses are made progressively as market prices change and I assess my performance on that basis by taking into account both realised and unrealised figures
Those that believe otherwise , in my opinion , are not facing up to the true situation

To evaluate how well or badly you are doing based solely on realised profits or losses gives an entirely false impression

For example take two investors

Investor one has one good investment which he sells and achieves a healthy realised profit of say $2,000 --- this gives him a lovely warm fuzzy feeling and he feels smart
He also has three bad investments which he holds on to as their combined market value is now say $2,500 less than their cost
He considers he has done his homework and is sitting on some gems , but it is just that the market does not presently recognise their true value and it will all come right given a bit of time and he will soon be in the money
He still has the shares so according to him he has not lost anything !

Investor two initially picked the same shares as investor one
But he very soon realised that he had three bad investments so sold them once this became clear and took a total realised loss of say $1,000 , but he also recognised that the other investment still had potential so retained it and it increased say another $250
Additionally he used the funds from the sale of the bad investments and re invested them in what he considered to be better opportunities and the value of those investments rose by say $500
He still holds them as he feels that they have further potential

The question now arises as to who has done the best
Investor one has a realised profit of $2,000 and unrealised losses of $2,500
Investor two has realised losses of $1,000 and unrealised gains of $2,750

Investor one has the greater realised gains but who has performed the best ?
Obviously investor two has , by a considerable margin
Overall investor one is worse off by $500 and investor two is better off by $1,750
( This would be the result if all investments were cashed up at this point in time )

Crystsllising losses is always painful , but especially so to the new or inexperienced investor --- it is so easy to sell the winners and end up holding the losers
This , I believe , is one of the worst and most prevalent mistakes committed by the inexperienced do it yourself investor

Invariably , the investor who retains winners (within reason ) and quits losers early will outperform by a considerable margin the investor who realises profits early on winners and holds on to losers
The object should be to build a quality portfolio and to avoid the underperformers ( not the opposite )

Gee , I feel a bit like a reformed alcoholic with a message --- but at an earlier time I have committed all of the investment mistakes which I have mentioned , at very considerable cost I might add

[Lawso]

Many thanks, whiteheron. I 4 1 have enjoyed this discussion and weighing up the various points of view. I especially appreciate your cogent, rational and literate!! summation.