It’s never easy to handle an investment that has gone down in value.
After all, this is your hard-earned money we are talking about.
Enduring the emotional pain of seeing your share prices fall is unpleasant.
But the question is: what should you do now?
There are choices to be made.
On the one hand, a fallen stock could be a chance to own more of an existing investment more cheaply.
But on the other hand, there could also be something wrong with the business, thereby justifying a sale.
The problem here seems much more acute than contemplating whether to add more money to winning positions.
After all, when losses are involved, the fear factor increases sharply and our brains tend to jump to action.
Unfortunately, acting rashly may only get you into deeper financial trouble.
When stocks decline, the right thing to do is to stay calm and to analyse the situation.
Only then can we make an informed decision as to what action should be taken.
A swinging pendulum
What you need to understand is that the stock market is more than just a place for businesses to raise money.
It also encompasses the hopes, dreams and fears of an entire group of investors.
Where money is involved, emotions will naturally run high.
Because of this, share prices can gyrate wildly like a swinging pendulum.
When investors are feeling optimistic, the pendulum swings up and brings valuations up to high levels.
The converse also happens: when bad news is announced, investors will swing the other way, panic and head for the exits, causing share prices to crash sharply.
Analysing the reasons for the drop
Now that you get a picture of why share prices sometimes behave the way they do, it’s time to analyse the reasons for a decline.
There are three possible scenarios here.
The first is that the company is facing a temporary, one-off problem that will have a significant impact on its profit or cash flows.
An example may be the loss of a bid for a large and promising contract, such as the case of iFAST Corporation Limited (SGX: AIY) not managing to win the Singapore digital banking licence bid back in December last year.
Because investors had expected a win, they may have pushed up the share price of the company in anticipation.
When the disappointing news is released, investors then sell their shares and the flood of sell orders pushes the share price lower.
Yet, even as the stock price jumped and fell, there was nothing fundamentally wrong with the company and it may still qualify as a promising investment candidate.
In such a case, it may make sense to consider adding to your position.
The second scenario is when a company faces a more permanent, structural change in either its business or operating environment.
Take Singapore Airlines Limited (SGX: C6L), or SIA, for example.
The COVID-19 pandemic has decimated air travel and plunged SIA into one of its deepest crises.
Even when the all-clear is given for flying to resume and borders to reopen, the airline could be faced with a very different industry landscape by then.
Investors have to evaluate whether these changes may permanently alter SIA’s prospects for the foreseeable future.
Finally, the third scenario is when there is no news surrounding a company, implying that there is no logical reason for the decline.
Revisiting your investment thesis
It’s important to constantly check if an investment is still fulfilling your investment thesis.
More so after the business experiences changes that may impact its prospects.
Revisiting your thesis helps you to make a more rational and logical decision.
If the thesis is no longer valid, it may be wise to think about reallocating the money to a more promising investment.
But if the thesis has not changed, you could decide to double down on the position to increase its weightage within your investment portfolio.
Get Smart: Doing nothing is also an option
Not every decline has to be met with action.
Remember that activity alone does not make you a great investor.
There will be cases where you should neither buy more nor sell off your existing position.
Instead, you can choose to do nothing and monitor the company for corporate developments.
And that may sometimes be the best option for the Smart Investor.
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Disclaimer: Royston Yang owns shares in iFAST Corporation Limited.