Know Your Limits

Emotions also play their part when it comes to managing downside risks. Indeed, nobody likes to lose. But more often than not, aspiring investors get too attached to their investments and don’t want to admit defeat in hope that the stock will recuperate its losses.

Keep in mind that the fundamental outlook of a company may change. That’s why it’s in your best interest to monitor the situation, reevaluate your expectations, and cut your losses if things go downhill.

You should set a limit on how much you would let the price drop before you sell. For example, you may want to cut your losses at 10% to protect your portfolio from further declines.

Remember, there’s a lot of random fluctuations in stock prices. Even if a stock’s price drops, this doesn’t mean you’ve made a bad investment decision. But once you’ve set a rule for when to sell, whether it is the company’s fundamentals or the stock price, you should stick to your rule. Doing so will allow you to reallocate your money to a better investment opportunity.

Oftentimes, taking a loss may turn out to be in your best interest for tax purposes. Realized losses can offset capital gains from other investments, thus reducing the amount of tax you’d need to pay. The fancy term for this is tax-loss harvesting.