Changing racing team in mid-season

A friend and I were talking about the alternatives he was facing in dealing with some unprofitable investments. The hang-up for him was that selling now meant “locking in the losses for good” whereas I argued for treating the current state as a done deal (tax consequences aside) and searching for other investment opportunities with more appealing prospects. After all, there is no law of physics or 11th commandment (accidentally lost by Moses as in this clip) that says “Thou shalt never lose money with thy mutual fund.”

But there was no way to convince him and so I left without being of much use. Sometime afterwards I thought of the following analogy and wished I’d share it with him.

We are in the middle of the racing season and your F1 team is last; you are pondering what to do. Mixed feelings of pride and loyalty to your staff compel you to stay the course, but deep inside you know you simply don’t have the goods (pilot, car, engineers, whatever). One day the owner of the current lead team pays you a visit and proposes an exchange: for no money, well maybe only legal fees, he’s willing to give you his team and take on yours, keeping the owner rankings unchanged (in other words, he will keep first place with your team and you will keep last place with his team). Stunned, you tell your competitor you need to think this over for a minute or two. What will you do: continue with your current set-up and hope to recover the lost ground or make the swap and see if you can recover faster with the obviously better team?

That’s really the conundrum of my friend and so many other investors I have met in similar situations in the past. To see this, substitute your current team with your losing position, your competitor’s team with your potential alternative(s) and the legal fees with brokerage commissions. You may say that the analogy does not really apply in the case of investing; after all no one is going to show up and give you the winning anything. This is only partly true. First, there is no guarantee the winning racing team will keep winning. Second, as for the generous owner, he exists inasmuch as you can choose with little effort from many different alternatives in the pursuit of your objectives.

The above decision is not easy. We don’t like to admit failure and perhaps even less have the stamina for looking at different solutions. The task is further muddled by the variety of potential short term results and by the fact that your current position may indeed be the best suited to recover your losses. The important thing is not to take it for granted and do some homework before staying the course.