One of my favorite parts of this job is taking questions from readers.

A question I’m often asked is, “What do you do when you own a stock that’s down a lot?”

I remember someone asked me that a few years ago, adding on, "What do I do about this problem?"

In response, I asked, "Is there a problem?"

Being down a lot in a particular stock is no fun. But it happens to even the most disciplined investors.

It's only a problem if you think the stock will continue going down much further or if you've put yourself in a vulnerable position.

What to Do When a Stock Is Down a Lot

The first and most important goal is understanding your holdings' balance sheets.

A stock being down is what economists call a "sunk cost." This means there isn't anything you can do about the situation, and you need to think about the future.

Think of it like a car accident.

You may have made a mistake that got you into an accident. There's nothing you can do to go back and change what happened, but there is something to be learned from it for the future.

However, immediately after the accident, you need to focus on what to do next.

That could mean pulling off to the side of the road, calling the police, or getting the insurance information of the other parties.

The same thing is true with your stocks. You can't change what happened, but you can change what happens next.

To start, examine one of your stocks that's down and assess why it's down and whether it will recover.

Begin with the balance sheet and the viability of the business. Does it have positive profits and cash flow? Is there much debt?

Next, look at why the stock went down and if that's subject to change. Are earnings or profitability down a lot? If so, is it caused by something temporary? And does the original reason you entered into the position still hold?

The most important part of this analysis is to remain objective. It's easy to react emotionally when facing significant losses.

Most of the best long-term stocks in market history had massive drawdowns at some point. Reacting emotionally while holding those would have been a colossal mistake.

This doesn't mean to do anything, but it does mean you should remain calm and collected when analyzing the situation.

Assess the Damage and Make a Call

Apart from the individual stock risk, there’s another point to consider. Does the stock being down affect your overall portfolio or financial situation?

Going back to the car accident analogy, you need to reflect on what you could have done better in the situation.

Suppose you find that a loss in a specific stock affects your overall finances. In that case, you must rethink your portfolio construction and risk tolerance.

Barring a situation where you own the stock because you're an employee or entrepreneur, it’s a mistake to make one holding so large that it can affect your overall financial health.

Long-term portfolios don't need much diversification to be effective — maybe 10 to 15 stocks at most — but diversification is still essential to constructing your personal investments.

Along with looking at how you could have sized the position differently, you should also consider why it went wrong.

Was it simply a high valuation in a frothy stock market? This has been the most common issue recently.

The solution is to be as aggressive in taking profits as you are in buying stocks.

This, along with diversification, should allow you to book profits significant enough to alleviate the sting of a selloff.

Finally, after you've completed this objective analysis, remember that most of the time, the best thing to do with long-term investing is absolutely nothing.

If the position is not a problem and your thesis has stayed the same, stick with your position and you will be rewarded over time.