Knowing When to Sell
The difference between an investor and a gambler is that a gambler will keep doing it until he loses. In the short run, the market is very risky, and much like gambling we take positions based on judgments about the probabilities of various outcomes, and the resulting expected values. But in the long run, earnings matter. Remember, any investment is only worth the present value of the cash it can give you back. Here are 3 tips to keep in mind when considering when to sell:
1. Do not let emotions determine your decision. A common investor mistake is induced by the tendency of investors to anchor emotionally. Selling at a loss makes it real, and they’d rather defer the pain of realizing a loss by waiting to get back to even.
2. The price paid for an investment is irrelevant to the sell decision. Except for the secondary consideration of taxes, in non-retirement accounts, the price paid for an investment should not be a significant factor when deciding to sell. When an investor asks if he should sell because he’s doubled his money, it begs the question of whether he would buy the investment if the entire portfolio were suddenly cash.
3. The all cash test is a good exercise. Pretend that when you wake up in the morning, all of your investments are in cash. Now, figure out the best way to invest based on your current circumstances in today’s market, without regard to past decisions that might have been made with imperfect knowledge and wisdom. Free yourself from the baggage. What difference does it make what you paid for something? Isn’t it more important to assess the potential returns going forward? And if the market is down, what difference do taxes make? Selling and repositioning can create tax losses to carry forward to shelter future gains.
For many investors, avoiding change seems to eliminate the risk of making a mistake. Unfortunately, either way a decision is made. Everyday you do not sell, you are implicitly saying you would buy.