It's as much a phrase to live your life by as it is an investing truism...
Don't throw good money after bad.
If you don't enjoy an activity, maybe you should quit... even if you've put in a lot of time. Or if you have a negative relationship in your life, maybe it's time to move on... even if the history is deep.
In investing, throwing good money after bad usually means doubling down in a losing trade. You tell yourself that your idea was right, just ill-timed. So you buy more... only to see prices move further against you.
It's almost always better to cut your losses at the first chance – because the more time and money you've put in, the harder it gets to sell.
Some investors are facing that problem right now. Prices keep falling in a major global market... But these folks keep buying. And unfortunately, that's a recipe for disaster.
Let me explain...
People throw good money after bad because of something called the "sunk-cost fallacy." In other words, quitting is hard once you're heavily invested in something. And that's even if cutting your losses is clearly the right thing to do.
Selling means letting those losses materialize. It also means admitting you're wrong. Neither is much fun.
But you'll have an even worse time chasing prices lower. That's almost always a losing strategy.
Just ask the folks pouring money into Chinese stocks over the past two years...
We can best see this happening in the iShares China Large-Cap Fund (FXI). This exchange-traded fund ("ETF") holds a basket of the largest companies in China.
Large-cap Chinese stocks peaked in February 2021. And they've since been in a brutal decline. While FXI has inched up about 30% from the October 2022 low, it's still down nearly 50% from that 2021 high.
You'd expect investors to give up on this group of stocks as a result. After all, dramatically falling prices tend to scare everyone away... especially if prices have been falling for years, not months.
But investors did the exact opposite.
FXI's shares outstanding are hitting a multiyear high. Take a look...
ETFs like FXI create and liquidate shares based on investor demand. So a rising share count tells us that the masses are pouring money into FXI.
Interestingly, the bottom for shares outstanding in 2021 was near the exact top for FXI. That indicates investors bought more and more of the fund as prices fell nearly 50% over the past two years. Shares outstanding have more than doubled in that time.
This is the "throwing good money after bad" phenomenon in action. And it's painful to watch.
I'm sure the people making this bet see lower prices and assume two things... that they're getting better value and that it'll all work out once prices recover.
But these investors are missing a crucial fact... that FXI is now a crowded trade. FXI's shares outstanding are at a 10-year high. And that means shares won't likely soar to new highs anytime soon.
Now, I'm not saying Chinese stocks will be "dead money" forever. But what has happened over the past two years is a cautionary tale. You'll always need a plan to sell... And throwing good money after bad is something you should avoid at all costs.
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