When to cut your losses: 10 years of lessons from my fund picks

Stock markets on both sides of the Atlantic have been on a rollercoaster. From a high of just over 6,100 in February, the S&P 500 index dipped briefly below 5,000 in early April on the back of the US President’s ‘liberation day’ tariffs. Two months on, it has regained almost all of its losses to sit just above 6,000 again.

Same story over here. The FTSE 100 peaked in early March at nearly 8,900, fell below 7,700 after the April tariffs announcement and, as in America, has regained all its losses in short order. The UK benchmark narrowly failed to close at a new all-time high on Wednesday.

The swings in sentiment on either side of the pond have been dramatic, if at times puzzling. The alacrity with which investors have regained their mojo in the past couple of months seems curious set alongside tariffs which remain far worse than at the start of the year. The ‘buy the dip’ optimism is also at odds with a big, but I would say ‘far from beautiful’, bill that promises a spiralling US deficit and undermines long-standing fiscal accords between the US and the rest of the world.

The volatility of global stock markets so far this year suggests I’m not the only investor to be confused. But my interest in the gyrations on Wall Street and here in London is, for the purposes of this column, more practical. It has got me thinking about the pros and cons of cutting investment losses and running profits - because the wisdom of both approaches has been given a stiff road-test in recent weeks.

The strategy of cutting losses quickly and allowing stock market profits to run is a common rule of thumb. The theory is that systematically cutting losses early prevents them from becoming potentially more damaging falls. Doing so limits losses, leaving more of your capital intact to gain from better investment decisions. Meanwhile, running profits allows you to capture the full potential of profitable trades. Both are good from a psychological perspective, helping investors avoid emotional, and therefore sub-optimal, decisions.

But the jury is out on whether the strategies really work in practice. Cutting losses runs the risk of prematurely closing out a trade that might have gone on to make significant gains. Selling at the market low in early April would have been an extremely expensive mistake, in the short term at least.

It is hard to implement too, requiring us to accept that we have got it wrong and to write off not just money but emotional investment too. Running profits is easier than cutting losses but it too can be stressful if you are scared that the gains you have so patiently built up might evaporate because you failed to crystallise them in time.

So much, so theoretical. How does it work out in practice? One of the advantages of having made annual fund recommendations to our personal investors over the past 10 years is that I can test these trading rules of thumb against lived experience. Here are some of the things I’ve learned from the performance of my picks since 2016.

That first year provided an important lesson - the danger of over-reacting to an early disappointment. The first six weeks of 2016 were tough for investors. The MSCI World index fell by 11% by the middle of February and my picks for the year - Rathbone Global Opportunities, Schroder Tokyo and Fidelity Moneybuilder Dividend followed the market down. Had I implemented a stop loss at, say, 10%, I would have crystallised a fall in value that went on to be more than reversed by the year end. The three funds were up by between 6% and 16% 12 months on, all three outpacing the global index over the year.

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More importantly, bailing out early would have meant missing out on further modest gains by the Schroder and Fidelity funds, in the years since 2016, and a spectacular one by the Rathbone portfolio. A £100 investment in the Rathbone fund ten years ago is worth just over £300 today. Please remember past performance is not a reliable indicator of future returns.

2019 and 2020 delivered another important lesson - the importance of distinguishing between your personal investment choices and broad-based market movements over which you have no control. At the start of 2019, I recommended four funds - the Baillie Gifford Japanese, Lindsell Train UK Equity, Fidelity Global Dividend and Fidelity Select 50 Balanced fund. By the end of that year, all four were usefully ahead. However, three months later, after the outbreak of Covid, all of them had given up their 2019 gains. A rolling stop loss would have kicked in at the low point. Again, this would have been a mistake. The Fidelity Global Dividend Fund has since doubled.

Perhaps the most interesting lesson was provided by 2021’s recommendations. That year’s picks have delivered a wide range of outcomes. The best has turned £100 into more than £160 over four and a half years. The worst is still more than 20% down and has gone sideways for the past two years. Foresight UK Infrastructure is showing no sign of getting back above water.

So, one strategy for a diversified portfolio might be to systematically recycle persistent underperformers into the investments that are making you money. Some would think that not doing this is wilful stubbornness. As Warren Buffett famously said: ‘selling your winners and holding your losers is like cutting your flowers and watering your weeds.’

Had I done that two years ago, when the Foresight fund first hit a 20% loss trigger, I would have diverted the £80 I had left from an initial £100 investment into Fidelity Special Situations (the year’s best performing recommendation). I would be £7 above break even today with that slice of my portfolio, despite the poor start.

Of course, this analysis benefits from hindsight, which I didn’t have at the time. But, exercised with discipline, there’s a case for accepting defeat after a 20% fall and putting the proceeds back to work where momentum is on your side. In investment, as in life, it’s sometimes better to move on.

This article originally appeared in The Telegraph.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.