There is one skill that all of us must learn if we want to build wealth. The skill is so critical that without it, it would be very difficult, if not impossible to build wealth. Worse, it may lead us to lose whatever we may already make. The skill is this - cut your losses.
Sadly, though it is critical, hardly anyone talks about it. Even the many investment books that I read hardly ever mention it. They share about the 'what', the 'why' and perhaps even the 'how to'. But they hardly ever talk about what to do when the investment does not perform as well as it should.
I think one reason for this is because the concept is not sexy. By its' very nature, the concept of cutting your losses is admitting that you have been wrong. And that is about as much fun as a visit to the dentist!
But just as visiting the dentist is important to our well-being, so is learning to cut our losses.
Why is that so?
See, common sense will tell us that we cannot win all the time. We cannot get it right 100 percent especially when it comes to investments. In fact, especially when it comes to investments! Investments, by its very nature, involves risks, which in English means that there is a chance that things will not turn out as we planned. Yes, we can increase our chances of winning by doing our homework about the investment before parting with our money. However, the fact still remains that the risk is still there no matter how much research you and I do.
So, we cannot win all the time. In fact, if we get our investment choices right 80 or 90 percent, that is a very good batting average. You and I will be very wealthy indeed with that kind of average.
Still, that means that some 10 or 20 percent of our investment choices will not turn out the way we planned. In fact, it may turn out to be total losers.
By the way, and this is another important skill, when some of our investments turn south, it does not mean that we are less of a man. All it means that we have just made an error in judgment about that particular investment. In fact, we may have chosen correctly when we made the investment. However, recent events may have annulled all the good skills, and so the investment is now a loser.
When it happens, and it happens to the best of us, we must cut the losses. Sell them off, salvage what's left, learn the lesson and get ready for the next investment.
In case anyone missed it - cutting our losses mean we will lose money, which is perhaps another reason why the concept is hardly talked about. Telling investors that they will lose money is the equivalent of asking them to change their loyalty to a different football team! Sacrilegious!
But you must do so if you want to build wealth. You must learn to accept that (a) you cannot win all the time, (b) some of your investments will turn out to be losers, and most important of all, (c) you must sell them even at a loss.
If you cannot or will not do this, it is a very unlikely that you will build wealth. If you hang on to the losers, there's no telling how much money you will lose. Worse, it will reduce or perhaps even eliminate the capital you have for the next investment. And if you hang on to enough of these losers, it will seriously dent your finances.
I mentioned earlier that you may get one or two wrongs when it comes to investments. Actually, I'm being kind! The reality is that most people will get it wrong at least half the time when it comes to investments! So you now you see why refusing to cut losses will do serious damage to one's finances.
If it will help, you should know that even millionaires, multi-millionaires and billionaires lose money. Yes, even Warren Buffett, Peter Lynch and George Soros have lost money. They have accepted the fact that they cannot get it right all the time, so they build in safety margins which include selling off losing concerns. Of course, they are not happy about it but they accept that is a part of building wealth. So if an investment is not performing as it should, they will sell it off even at a loss, and put it to better use in other investments.
So to summarize, if an investment is not performing as it should, sell it, even if it means you have to take a loss. Salvage the money, learn the lesson and get ready for the next investment.
It is a prerequisite for building wealth.
Azizi Ali is Malaysia's premier writer, speaker and coach on money matters. He is a Chartered Financial Consultant (ChFC) and holds an MBA from University of Bath, UK.
Log on to http://www.beahappymillionaire.com to find out more about Azizi and how he can help you lead happier prosperous lives.
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