How to Turn a Bad Investment Into a Good One

How Do You Identify a Bad Investment Choice?

There are several different signs that an investment decision you've made wasn't the right fit for your portfolio. Here are some to consider as you review your holdings:

• It doesn't align with your goals. Depending on your risk tolerance or time horizon, some investments may not match your investment strategy and goals. For example, if you're saving for retirement in your 30s and can afford to take on more risk, it may not make sense to invest heavily in low-risk, low-reward bonds. Conversely, if you're a few years out from retirement, a stock-heavy portfolio could be too risky.
• You bought into hype. If you bought a meme stock or cryptocurrency based on hype from an internet forum or the media instead of solid research, holding on to your position may not pan out in the long run.
• You've already sustained a serious loss. It's natural for investments to fluctuate in value. But if your position has tanked since you made the trade, the likelihood of it returning to the price you bought it at may be low.
• You're trying to time the market. Timing the market is impossible, but that doesn't stop investors from trying. If you were hoping to take advantage of short-term price fluctuations and you're currently waiting to get the return you want, you may be disappointed.
• You don't know anything about your investment. One of the best ways to succeed in investing is to buy what you know. If you didn't take the time to research your investment decision to determine if it's a good fit for your portfolio, it may have been a poor choice.

If you've made any of these mistakes, it's important that you don't feel guilt or shame regarding your decision. There's a steep learning curve when developing a solid investment portfolio, so it's good to be as objective as possible about your past decisions and their potential for future returns.

When Is It Time to Cut Your Losses?

While selling a stock, mutual fund or other type of security that's performing poorly may feel like you're admitting defeat, it's a crucial step in maximizing your investment gains.

The last thing you want to do is give in to the sunk cost fallacy, which is when you throw more money at a bad investment with the hope that it'll rebound. Continuing to chase after an investment that may never turn around can result in devastating losses.

As there's no way to predict success in every investment decision you make, it's to be expected that some investments won't result in gains. When developing your investment strategy, include provisions for when to cut your losses. Possible ways to do this include:

• Setting a specific threshold: You may decide that you'll sell any position once it's lost a certain percentage in value, say 5% or 8%. You can even set up a stop-loss order when buying a stock to have the broker automatically sell it if it reaches a certain price. Selling when an investment price is low will cause you to realize losses, but it could stem the tide of even more capital loss.
• Selling stocks that underperform: It's generally best to avoid selling when the whole market is down. But if you notice that one of your stocks or other securities is underperforming when the rest of the market is up, it may be a good time to get rid of it.
• Reviewing your portfolio regularly: It's a good idea to review your investment portfolio at least once a year to determine whether it's still in line with your investment strategy and goals. If you notice some losers or simply want to make adjustments to your asset allocation, make some trades to cut losses and ensure that your portfolio is working the way it should.
• Checking your attachment: It's possible for investors to get emotionally attached to investment decisions. If you find that you're overly attached to a specific stock, crypto asset or other security that isn't performing well, take some time to review its performance objectively. Even if you haven't sustained any losses on your position, an underperforming investment can still hold you back from achieving your goals.

How to Turn Bad Investments Into Good Ones

The earlier you accept a bad investment decision, particularly if you're losing money, the more money you'll save and the faster you'll be able to put that money to better use elsewhere. Depending on your situation and goals, here are some potential steps you can take to make the most of a poor investment once you've sold it.

Buy an Exchange-Traded Fund

If your portfolio is largely made up of individual stocks, you may consider mitigating some of the risk with an exchange-traded fund (ETF). ETFs function similarly to mutual funds, allowing you to diversify with a wide range of stocks, bonds and other assets, but they tend to be cheaper and trade on major stock exchanges.

ETFs also make it easier to follow a passive investment strategy, which is often less risky and expensive than an active approach.

Invest in Something That's More Aligned With Your Goals

If you made the original investment decision on a whim or without sufficient research, take some time to consider your investment strategy and goals to determine where you can put that money to better use.

For example, you could bolster an existing position in your portfolio by buying more shares, or you could research other stocks, funds and other securities to see if they can fit in well with what you already have.

Diversify to Other Assets

If you have a lot of money in stocks, you may consider using the funds to buy some bonds, real estate or other assets that don't necessarily fluctuate with the stock market. Having a good mix of assets can help diversify your portfolio, limiting your exposure to risk within each asset class.

Pay Down High-Interest Debt

If you have credit card debt, you're likely paying a higher interest rate than you could reasonably earn in your investment portfolio. Consider using some of the money from your trade to pay down high-interest debt to free up more cash flow for investing and other financial goals.

The Bottom Line

Regardless of how much experience you have, you're bound to make poor investments now and then. Instead of beating yourself up or holding on with the hopes that it'll turn around, decide when it's the right time to cut your losses and make adjustments to your portfolio so you can minimize exposure to bad investments in the future.