Stuck in the mud

Every driver knows the sinking feeling that hits them when they realize they are stuck. Wheels helplessly spinning while going nowhere.

We’ve all been there. Maybe after a snowstorm.  Maybe trying to navigate a sandy beach parking lot in a rental car with bald tires. Or, as the saying goes, maybe in the mud.

Getting stuck in an investment can be an equally frustrating experience.

Photo by Aubrey Odom on Unsplash

Maybe it’s a private fund that has put up “gates” to stanch the flow of redemptions, allowing the manager to avoid the need to sell assets in an illiquid market.

Perhaps it’s a private company that has lost all momentum, with any potential exit or IPO now just a distant dream.

Or it can even be a small public company, once an underground message board darling, now floundering at mere cents a share, with no adequate “bid” to speak of.

This has happened to me too many times to count, especially in my risk-taking youth. Like most value investors, I loved the idea of finding an undiscovered gem. Perhaps a promising microcap stock. Or maybe a tiny gem trading on an illiquid foreign market. These stocks can be easier to buy than to sell. The bid-ask spread can be a massive chasm, and if your investment is large enough, a market sell order could send the stock down to near zero. The result: limit orders that sit there for days, then weeks, then months. Worse, while you wait patiently for buyers to hit the ask, the stock price drifts lower, and investor interest in the name dries up. There have been no posts on the message board for months. Punters have long given up on the stock.

Getting out can feel liberating. Like finally getting some traction under those wheels, you can finally drive away and leave that horrible memory in the rear view mirror.

The best case scenario is that you take your loss and the stock sits in the dumps forever. You took a loss, but it could have been worse.

The worst case scenario is that soon after you sell, the stock finds a bid and takes off to the upside. Not many things in the investing world more frustrating than that.

Look, I’ve been through all of these scenarios. Ultimately it’s been a part of shaping my philosophy and leading me to write Low Risk Rules. I’ve got the scars to prove it, and I’m hoping you can learn from my misadventures.

I’ve created a little rule to protect myself from these situations, as they often tend to rely on a catalyst to unlock value. As a general rule, you shouldn’t buy anything you wouldn’t be comfortable holding for the next decade or two… because economic cycles can change quickly and unexpectedly… leaving you holding the bag and unable to sell if the story doesn’t play out as you expect.

So why are you buying that stock?

If it’s about allowing the growth of the business to compound capital over time, you’re on the right track.

If it’s an event-driven thesis or a quick flip — if you’re buying a stock for the sole purpose of selling it — you should beware the potential to get stuck.

Because here’s what might happen. Sure, you might be right about the event you’re anticipating. Maybe the stock will double, or triple. You can lock in a quick gain. Then you’ve got to pay tax and look for another investment idea to redeploy the gains. Even if you’re right, it’s a difficult and tiring game to play.

If you’re wrong, you could be facing a loss. If there are fewer buyers around and the stock is illiquid, the stock might be hard to sell. As you take your time to liquidate, your loss may increase. In order to avoid taking the loss and admitting your defeat, you might just hold onto the stock, hoping it goes up in price. You may inadvertently end up with this miserable little company in your portfolio forever.

Or you could do it an easier way. You could buy a high quality company with a strong management team. You could tuck those shares away. You could forget that you own them and forget about trading them and just let the compounding work for you.

I’ve done it both ways. The low risk anomaly tells us that there are no bonus points for doing it the hard way. I choose the easy way.