Every investor knows they should cut their losses sooner. Most struggle to do it.
By Clare Flynn Levy
Clare Flynn Levy is CEO & Founder of Essentia Analytics. Prior to setting up Essentia, she spent ten years as a fund manager, in both active equity (running over $1B of pension funds for Deutsche Asset Management), and hedge (as founder and CIO of Avocet Capital Management, a specialist tech fund manager).
Most of us know that cutting our losses is usually the rational thing to do. Yet when the moment comes – whether it’s exiting a losing investment or walking away from a job, a project, or even a relationship – we hesitate. We justify, we delay, and we hope. And, in many cases, we allow the loss to grow.
Annie Duke captures this dynamic clearly in Quit, arguing that humans are wired to stick with things long past the point where quitting would improve our outcomes. Persistence feels virtuous, while quitting feels like failure — even when the data suggests otherwise.
The investment industry offers a rich, real-time illustration of this challenge. In our work at Essentia Analytics, we see it every day: highly skilled professionals who can analyze businesses with extraordinary clarity struggle to cut their losing positions early enough. And the data shows that this hesitation has measurable consequences.
The Behavioral Biases That Get in the Way
Several well-documented biases converge to make loss-cutting difficult:
- Loss Aversion: Losses loom emotionally larger than gains, making the act of realizing a loss feel disproportionately painful.
- The Endowment Effect: Once we own something – a stock, an idea, a material object – we tend to overvalue it. This effect is especially visible in Essentia’s Alpha Lifecycle research, which shows that portfolio managers often hold positions well past the point where they are adding value.
- Sunk Cost Fallacy: The more time or effort we’ve invested, the harder it becomes to walk away – regardless of the opportunity cost.
And when investment performance has challenged us for a sustained period — against a backdrop that includes client pressure, internal scrutiny, or even quiet fears about job stability — the emotional cost of crystallizing a loss increases sharply. Behavioral biases exert exaggerated influence, thanks to cognitive depletion.
The experience of being wrong feels identical to the experience of being right — right up until the moment you realize your error.
Cognitive depletion is what happens when the constant load of uncertainty, decision-fatigue, and scrutiny exceeds the brain’s capacity to replenish its energy and focus. And when depletion sets in, investment teams don’t make worse decisions because of lack of knowledge — they make worse decisions because their intellectual “fuel tanks” are empty.
This often leads to decisions NOT to act, for example by:
- Holding on to once-hero stocks that have rolled over, far past the point where the thesis has deteriorated
- Framing sell decisions emotionally (“we can’t give up on it here”)
- Defaulting to narrative (“it looks cheap”) rather than curiosity (“what are we missing?”)
- Waiting for “one more data point” that never materializes
- Feeling exhausted by the thought of revisiting long-held positions yet again
It’s not stubbornness — it’s self-protection. As Kathryn Schulz explores in Being Wrong, the experience of being wrong feels identical to the experience of being right — right up until the moment you realize your error.
That moment of transition is what’s so destabilizing: it’s not just an intellectual correction, it’s an identity disruption. And in investment management, where your track record is your professional identity, the stakes of that disruption feel existential.
The problem is that protecting future identity (“I don’t want to be the PM who sold this at the bottom”) often conflicts with protecting future returns. Recognizing this emotional dynamic is the first step to interrupting it.
What the Data Shows About Loss-Cutting in Practice
Essentia’s decision analytics give us a unique lens into how professional investors actually behave when it comes to managing losers. And the data shows a consistent pattern across the industry: scaling out and exit decisions are among the weakest areas of investor skill. As Essentia’s Alpha Lifecycle research confirmed, most long-only equity fund managers hold on to positions too long — winners that “round trip” and losers that were wrong from the start.
So what’s an investor to do?
How to Get Better at Cutting Losses
If step one toward getting better at cutting losers is recognizing the emotional dynamic at play, then step two is realizing that most fund managers get their stock picks wrong most of of the time.
In Stock Market Maestros, my new book co-authored with Lee Freeman-Shor, we found that the average hit rate (ie, the percentage of winning stock picks) for the most skilled fund managers’ ideas was only 49%. Where their skill came into play was in the execution: how they behaved when they were winning and how they behaved when they were losing.
Most fund managers get their stock picks wrong most of of the time.
In the book, the Maestros we profile employ a wide variety of techniques to mitigate their behavioral biases when it comes to cutting losers. But there are some common principles that recur in their investment processes.
Define exit criteria at the entry point, when everyone is optimistic. How will you know you’re wrong? Over what time frame? What would break your thesis? Keeping this “pre-mortem” to hand over the life of the position can stop “thesis-creep” in its tracks.
Create structured review points, ideally based on data evidence, where you commit to asking a very deliberate set of questions aimed at making an unbiased decision. Most popular? “If I didn’t already own it, how much would I buy today?” This is what Essentia clients do automatically, with nudges, and we can prove that it does result in better decisions.
Reframe the “quit.” The reality is that getting out of a stock today does not mean you can never buy it again. Thinking about cutting the loss as “stepping onto the sidelines” — rather than quitting the game forever — can significantly reduce anxiety around the decision.
Loosen the lid. For some investors, selling a small amount of stock in advance of exiting can serve to dampen the stress that comes with making a big loss-cutting decision. Just don’t make the mistake of stopping there — Essentia’s analysis regularly identifies managers who destroy value by trimming, then waiting months to finish the job. Loosening the lid is about opening the jar; you may still have to empty it.
Celebrate good quits. When you’ve taken a loss, celebrating is the last thing you want to do. But six months later, have a look at what would have happened if you’d stayed. The more disciplined you are at getting out, the more often you’ll find you saved yourself a lot of additional pain by acting when you did.
The Bottom Line
Cutting losses is hard to do. We humans are hardwired to avoid the emotional discomfort of being wrong. But the data — from academic research to Essentia’s decade of analyzing professional investor decisions — suggests that learning to quit well is a competitive advantage. And when your odds of being right are actually less than 50%, creating and executing a system for objectively recognizing when you’ve got it wrong is the greatest process enhancement a sophisticated investment team can make.
