Should I Hold a Losing Stock? 4 Smart Strategies for Underwater Investments

We’ve all been there – checking our portfolio and seeing that red negative number next to a stock we were once excited about. The gut reaction is often to hold on hoping things will turn around. But is that always the smart play? As someone who’s made plenty of investing mistakes (trust me, my portfolio has had more red days than I care to admit) I want to share some real talk about what to do with those underwater investments.

The Emotional Rollercoaster of Losing Stocks

Let’s be honest – nobody likes to admit defeat. When we buy a stock we’re essentially saying “I believe this company will be worth more in the future.” So when that stock drops instead, it feels like a personal rejection. Our brains are wired to avoid pain which is why so many investors fall into the trap of holding losing stocks far longer than they should.

I remember buying shares of a tech startup that seemed promising, only to watch it drop 30% over six months. I kept telling myself, “It’ll bounce back!” Spoiler alert: it didn’t. I ultimately sold at an even bigger loss than if I’d just cut my losses earlier.

4 Smart Reasons to Consider Selling Your Losers

According to investment experts at Charles Schwab, there are four compelling situations where selling a losing stock makes good financial sense:

1. You Want to Realize Some Gains Elsewhere

This strategy is called tax-loss harvesting and it’s one of the few silver linings of having losing investments.

Here’s how it works: Let’s say some parts of your portfolio have done really well, and you want to lock in those profits. Selling those winners means you’ll owe capital gains tax. But if you also sell some losers, you can use those losses to offset the gains, potentially reducing your tax bill significantly.

For example, if you’ve realized $10,000 in short-term capital gains but also have $15,000 in capital losses, you can completely offset those gains and potentially use the remaining $5,000 in losses for future tax benefits.

2. You Need to Reduce Your Taxable Income

Even if you don’t have investment gains to offset, those investment losses can still be valuable! The IRS allows you to use up to $3,000 in investment losses each year to offset your ordinary income.

And get this – if your losses exceed $3,000, you can carry the remaining amount forward to future tax years. That means a significant investment loss could provide tax benefits for years to come.

3. You Need the Cash

There’s an old trading saying: “Let your winners run.” If you need to free up some cash in your portfolio, it often makes more sense to sell your losers rather than cutting short a winning investment that might continue to grow.

Plus, by selling those underwater investments, you can potentially offset up to $3,000 of ordinary income each year through tax-loss harvesting. It’s like getting a small consolation prize for your investment mistake.

4. The Investment No Longer Fits Your Strategy

This might be the most important reason of all. Sometimes we hold onto losing stocks because of what psychologists call the “break-even fallacy” – our natural instinct to wait until an investment recovers to our purchase price before selling.

But here’s the hard truth: that stock doesn’t know or care what price you paid for it. Its future performance will be based on the company’s prospects, not your purchase history.

If an investment no longer aligns with your strategy or if the fundamental reason you bought it has changed, holding on could just lead to bigger losses. Taking the hit now might allow you to reallocate those funds to better opportunities.

Important Tax Considerations When Selling Losers

Before you rush to sell those underwater stocks, there are some important tax rules to understand:

Short-Term vs. Long-Term Capital Gains/Losses

The tax treatment differs based on how long you’ve held the investment:

• Short-term losses (investments held less than a year) first offset short-term gains, which are taxed at your ordinary income tax rate
• Long-term losses (investments held more than a year) first offset long-term gains, which are usually taxed at lower rates (0%, 15%, or 20% depending on your income)

Any remaining losses of either type can then be applied to the other type of gain. This matters because offsetting short-term gains (which are taxed at higher rates) generally provides a bigger tax benefit.

The Wash-Sale Rule Trap

Here’s a rule that catches many investors by surprise: the wash-sale rule. If you sell an investment at a loss and then buy the same or a “substantially identical” investment within 30 days before or after the sale, you can’t use that loss for tax purposes.

This rule exists to prevent people from selling just to create a tax loss while maintaining essentially the same investment position.

What counts as “substantially identical” isn’t always clear, especially with ETFs and mutual funds. With individual stocks, it’s straightforward – you can’t sell Tesla at a loss and then buy Tesla again within that 61-day window (30 days before and 30 days after the sale date). But with funds, it gets trickier. To be safe, if you’re reinvesting after taking a tax loss, choose a fund that tracks a different benchmark or has a significantly different investment mix.

When Holding a Losing Stock Might Actually Make Sense

Despite everything I’ve said above, there ARE times when holding a losing stock might be the right move. Here are a few scenarios:

1. The Investment Thesis Remains Sound

Sometimes good companies see their stock prices fall due to short-term market conditions or temporary setbacks. If your original reason for investing remains valid and the company’s long-term prospects still look strong, holding might be reasonable.

Ask yourself: “If I didn’t already own this stock, would I buy it today at this price?” If the answer is yes, that’s a good sign you should consider holding.

2. You’re Investing for Dividend Income

Some stocks are primarily held for their dividend payments rather than price appreciation. If a stock’s price has declined but it continues to pay a solid dividend, the yield (dividend/price) actually increases. For income-focused investors, this might make the stock more attractive, not less.

3. The Entire Market or Sector is Down

If your stock is down but so is everything else in that industry or the broader market, it might not indicate a problem with your specific investment. During market corrections or bear markets, even great companies can see their stocks decline temporarily.

4. Tax Considerations Make Holding Preferable

Sometimes, tax considerations might make holding preferable, especially if:

• You’re close to qualifying for long-term capital gains treatment
• You expect to be in a lower tax bracket next year
• The loss isn’t large enough to provide meaningful tax benefits

My Personal Approach to Losing Stocks

I’ve developed a system that helps me make more rational decisions about underwater investments:

1. Regular portfolio reviews – I schedule quarterly reviews of all my holdings, with a special focus on any positions that are down 10% or more.

2. Reassessment of the investment thesis – For each losing position, I ask: “Has anything fundamentally changed about why I bought this stock?” Sometimes the answer is yes, sometimes no.

3. Consider tax implications – Towards the end of each year, I look for tax-loss harvesting opportunities, especially if I’ve realized gains elsewhere.

4. Set loss thresholds – For most investments, I set a mental “stop-loss” of 20-25%. If a stock drops below that threshold, I force myself to make a conscious decision about whether to hold or sell, rather than just ignoring it.

5. Learning from mistakes – Perhaps most importantly, I try to learn from each losing investment. Was there a red flag I missed? Did I buy for emotional reasons rather than fundamental ones?

Final Thoughts: Making Peace with Investment Losses

Investing isn’t about being right all the time – it’s about being right more often than you’re wrong, and managing your losses intelligently when they happen.

The most successful investors I know aren’t the ones who never lose money – they’re the ones who handle losses strategically, using them to their advantage when possible and learning from them when they occur.

If you’re holding a losing stock right now, take a deep breath and evaluate it objectively. Is it really likely to recover? Or are you just hoping to avoid the psychological pain of admitting a mistake? Sometimes, selling a loser is actually the winning move for your overall financial health.

And remember, even Warren Buffett makes mistakes. The difference is that he doesn’t let pride or emotion keep him from correcting those mistakes when necessary.

What about you? Are you holding any underwater stocks that you should probably reconsider? Maybe it’s time for an honest portfolio review.

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The “7% rule” for stocks is a risk management strategy that dictates selling a stock when it drops 7% below the purchase price to limit losses and preserve capital. This rule, popularized by investors like William O’Neil, is based on the observation that even strong stocks typically don’t fall more than 7-8% below their ideal buy point. It can be implemented by setting a stop-loss order with your broker or through manual monitoring. Another related, but distinct, “7% rule” is a retirement planning concept where you assume a 7% annual withdrawal rate from your investments to determine how much you need to save for retirement, as explained in this YouTube video.