Should you keep your winners and sell your losers?
Many people are getting their 2011 investment statements and I’m fielding lots of requests from people who want an objective second opinion on their portfolios. Because of the markets, many of these people are tired of losing money and want to see if there’s anything they can do to improve their returns. In fact I am getting enough of these requests that I thought it would make sense to share one of these case studies and my response with all my readers.
Keep your winners and sell your losers
It’s human nature to love your winners and hate your losers. Jack is a prime example of this. He has a portfolio in his group RRSP plan. Here’s how his investments performed last year:
- Bond Index Fund + 9.66%
- Moderate Asset Allocation + 1.88%
- Canadian Equity Index – 8.73%
- Global Fund – 6.28%
- International Equity – 9.85%
Jack’s gut reaction is to keep his winners and turf his losers. In fact, his natural reaction is consistent with most people’s instincts. Jack loves his bonds and hates his stocks. Jack is so frustrated with the stock market that he plans to sell his losing stocks and move more money into bonds.
Would that be your natural reaction too?
Buy low, sell high works better
If you practice keep your winners and sell your losers, you are in fact buying high and selling low which is the opposite of the one strategy that guarantees investment success.
Instead of buying high and selling low, the better strategy to making money is to buy low, sell high. If you think about it, that means selling some of your bonds to buy some equities. The problem is that’s not easy to do. The challenge is your instinct or emotions cause so many people to do the wrong things at the wrong time.
Keep your winners is like chasing performance
Back in 1999, I did a bunch of research on chasing performance for my best selling book, Mutual Fundamentals. I’m not exaggerating when I say I spend a lot of time, effort and money researching whether this strategy works for investors. My conclusion is simple: Chasing performance does not work
Others have also written on some the topic of chasing performance and although the research is different, the conclusion is pretty much the same
- A gloomy year, even for award winners
- When hot investments go cold. If you used asset class winners of 2010 t pick your investments for 2011, you were probably disappointed.
Forecasts are useless
I suggested to Jack that chasing performance does not work and that he may be better off rebalancing the portfolio to sell some of his bonds and buy more stocks. Jack was quick to point out that the forecast for the economy and the stock market did not look too good.
The problem is most forecasts and predictions are wrong and therefore useless. My favorite forecast comes from Dan Borolotti, the Canadian Couch Potato, “Of course, the crystal ball gazing is well under way for 2012. My only prediction for the year is that these forecasts will prove just as unreliable as always. Tune them out, build a portfolio for the long-term, and stick to your plan.”
I could not agree more. I was quick to point out to Jack that I do not have a crystal ball on the future and I am not able to forecast the direction of the markets to any degree of accuracy. In fact, I believe that anyone that puts to much effort in forecasting the future is wasting his or her time and effort.
What do you think about Jack’s strategy and my advice? What are you doing with your portfolio? Are you rebalancing? Or are you keeping your winners and selling your losers?
I think it’s very hard to resist the urge to sell your losers, but your reasoning is sound. I have 2 questions on this topic.
1. What if you think the company is pretty much doomed and may never rebound? I have a coworker with shares in Yellow Media, and to me, it seems he should sell..
2. I am thinking of getting out of my “managed” mutual funds, and moving into something with lower fees (like an ETF). But, of course, things are down right now. What’s your take on this idea?
Thanks for your comment Ellen
1. If you buy crap and hold crap, you will always have crap. Only hold quality and only buy more if it’s not crap (excuse the language).
2. lower fees is great! If you make a lateral move from a Canadian Equity Fund to a Canadian Equity ETF with lower fees then you are doing yourself a favour. If you move from a Canadian Equity fund to a Bond ETF, then you may be selling low and buying high.
I hope this helps!
1. I think crap is a perfectly good word to use here. 🙂
2. Yes, thank you for the information – I appreciate it!
Good advice Jim! Momentum investing works in bull markets; but it’s a trading strategy, not a investment strategy in my opinion. It usually ends badly.
If a sound investment falls is price you should probably buy more (within sound diversification parameters of course). We should try to buy our investments “on sale” just like we would other discretionary items.
Thanks for stopping by Ken and sharing your wisdom. It’s appreciated as always. I like the differentiation between a trading strategy and an investment strategy.
I really dislike these “rules of thumb”, because they remove the responsibility of the investor to actually look at what they’re holding.
I completely agree with your point 1 in your reply to Ellen, above, Jim. If someone is buying low and selling high into a portfolio that contains a bunch of dogs, they will inevitably be in trouble sooner or later, not matter how good the overall strategy.
Thanks for your comment Kevin. Right or wrong, I try to simplify concepts to a point where most people can understand. The main point of the post is to get people to fight the urge to buy high and sell low as a result of investor psychology influencing investor behavior.
I’ve talked about the importance of good research when selecting specific holdings. Over the years, I’ve become more in tune with holding indexes and low cost ETFs to reduce the need to deal with individual holdings.
Nice post Jim.
If I was Jack, depending upon his holdings, assuming he was in low cost ETFs, I would sell some bonds and add to equities. Especially the global/international portion.
I’ve done this already this year, in my RRSP. I bought some VWO many weeks ago because of the Greece crisis. Now I have a healthy gain.
Same with Canadian lifeco stocks. I’ve been buying as things fall or fall harder.
I’m with Ken on this one. Keeping winners and cutting losses on losers is a trend-following trading strategy. It can work well if you have a disciplined system. For the average investor, however, it’s probably better to stick to a basic rebalancing mechanism.
I like Mark’s approach too – especially with regard to Canadian insurers. This low rate environment is really hurting them, but they are starting to look like value plays for long term investors.
On predictions: there’s a difference between claiming you know what will happen next and simply making yourself aware of the underlying investment climate. No one knows where markets will go, but that doesn’t mean we need to ignore macro issues altogether. Investing blindly is never a good plan.
I’ve learn to stick with my asset allocation through thick and thin. Last year my emerging market did very badly and I still tried to bring up that allocation with new money. It is looking much better in 2012 so far.
I agree with the comments above about the re-balancing strategy assuming what you have bough still matches your criteria. It takes the emotion away from the process.
There is a difference between an ETF/Mutual Fund and individual stocks too. I would not just re-balance the same way with my stock portfolio but I do follow my investments much more and keep a pulse on them. Re-balancing stocks can be an expensive proposition but you should always consider selling a loser (which is crap) or adding to a loser to average down and benefit from a low price. Sometimes I may fund the purchase by selling a winner.
Evaluate stocks based on their P/E (should be under 15, but not under 5), Dividend Yield % (they shouldn’t, however, be paying out more than 80 or 90% of profit). Check their P:Book and P:FCF ratios to assess sustainability. To reduce risk, only pick it up if it’s got low Debt:Equity, Price:Book ratios, and a good interest coverage ratio. Then, ignore what Mr. Market does since you can be sure you bought in at a good price and enjoy the low-tax dividends, rather than trying to gamble for higher-tax capital gains.
I would only sell my losers if I needed the money to invest in something else, other then that I probably would not sale them.