What’s your sell discipline?
With any investment, there are two key decisions that have to be made. The first is when to buy and the second is when to sell.
In the investment world, a lot of time is spent on which investments to buy. You can find hot tips everywhere you look. For most investors, very little time is spent understanding when to sell and yet it is equally important as the decision to buy. This week, I met Jack who bought a penny stock a year ago and the stock has more than tripled. When I asked him when he was planning to sell the stock, he had no plans to sell since the outlook for the company still looked great.
Buy your winners and sell your losers
The problem with not having a sell strategy is that selling becomes a reaction to emotion. Investing is an emotional game, to begin with. We love investments that make money and we tend to buy more or hold on as investments go up. On the other hand, when investments drop, we tend to panic and sell.
Take a look at your portfolio today. Rank your investments from best to worst. Chances are, your natural instinct is to keep your winners and get rid of your losers. It’s human nature to react in this fashion but the real strategy that works is to buy low, sell high.
When I think of the best money managers, stockbrokers or the best financial advisors, typically they have a good understanding of both the buy and the sell-side of investing. Here are some thoughts on when it might be appropriate to sell an investment.
- You got it wrong. We all make mistakes from time to time. Sometimes investors are lead to hang onto an investment because the industry promotes the merits of buy and hold. The problem is the industry has both good investments and bad investments. If you buy a bad investment and hold a bad investment, you will always have a bad investment. Sometimes it’s best to cut your losses when you make that bad investment.
- Something Fundamental has changed. Whether you invested in a stock or mutual fund, remember that everything changes. Sometimes changes are for the better but naturally, it can change for the worse too. It is important to monitor your investments in case there is a fundamental change for the worse.
- Your personal circumstances have changed. One thing the investment industry is very concerned about is whether investments are ‘suitable for the investor’. Inevitably, your personal financial circumstances will change form time to time, which may lead you to be more conservative or more aggressive. Make sure your portfolio is adjusted accordingly.
- Rebalancing. Rebalancing is a strategy that forces you to sell your winners and buy more of your losers. In other words, buy lower and sell higher. I highly recommend that you rebalance a portfolio from time to time for this very reason.
- Profit-taking. If you go back to the example of Jack who has tripled his investment. Probably the most prudent strategy for Jack is to take profits and maybe sell a third of his investment. This way he will take out his original investment and only be speculating with money he never had.
- Set sell targets from the start. Many professional money managers set sell targets at the time they make the buy. This ensures there are some logic and discipline put into place to help keep emotions from running the show.
When it comes to investing, make sure you devote some time to understanding the sell-side of investing. If you are using a professional maybe one good question to ask is “What is your sell strategy?”