What to do with the duds in your portfolio

Nick Train, manager of the Finsbury Growth & Income Trust, is an excellent fund manager one of the few consistently to have beaten the market over the long run. But right now, one firm publisher Pearson is giving him a headache. Train first bought in nearly a decade ago, but since 2013 Pearson has issued five profit warnings the latest in January this year as it struggles to shift from being a diversified publisher to focusing on digital educational content.

Train is hanging on, but it's clear the stock hasn't done what he hoped it would when he first bought in. That's a horrible situation for any investor. So what should you do if you end up buying a dud?

Write it down: keep an investment journal (or spreadsheet). When you buy a stock, make sure you record details of why you bought it. If the price then falls sharply, you can return to your records and check if your rationale for buying still stands up. Why does this matter? Because we don't like admitting we're wrong, so our brains will jump through all sorts of hoops to justify our decisions retrospectively. If a stock has fallen by 30% from where you bought it, the chances are you made a mistake. Having it written down in black and white will force you to confront that mistake and act, instead of rationalising it away.

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Buy or sell never hold: in The Art of Execution, fund of funds manager Lee Freeman-Shor looks at what the most successful professional investors do when a stock they own plunges in price. They did one of two things they sold out, or they bought more. But they didn't just sit on the losing position. This makes perfect sense. If a stock slides in price, and you believe that your original rationale for buying still holds, or that the selling is overdone, then you should be keen to buy more after all, it's cheaper now.

If, on the other hand, you aren't willing to buy more, then it suggests you should swallow the loss and find better opportunities in which to deploy your depleted capital. This "fold or twist" approach forces you to be disciplined, and stops you from sticking with holdings that either go bust or malinger in your portfolio, stuck at 50% below your purchase price, because you can't face crystallising the loss.

Diversify: Train might be struggling with Pearson. But at the end of the day, it's a small part of an overall portfolio of high-quality global stocks drawn from various sectors that has done very well as a whole. So the occasional strategic error such as stubbornly sticking with a stock other managers might have dumped a long time ago hasn't inflicted too much damage on his returns. Like Train, you don't need to hold many stocks to be fully diversified 16 to 20 will do it.