Future Focus: When to sell your investment
We focus on what to buy, when is it actually time to sell?
Warren Buffett famously said his favourite holding period is forever.
Unfortunately, that isn’t particularly helpful for most investors.
Buffett was running a conglomerate with permanent capital and no personal liquidity needs. Most of us are investing for very specific financial goals. It could be a home deposit, financial independence or a comfortable retirement. These goals eventually require cash. At some point, most investors are going to have to sell their investments to fund their goals.
The decision to sell should be deliberate and align with your long-term outcomes. You want to avoid sell decisions that are emotional, reactive and ultimately are detrimental to your portfolio outcomes.
Increasing your odds of making a good decision requires structure. Lay out in advance the good and bad reasons to sell. Then – be more specific by outlining the exact conditions to sell holdings in your portfolio.
Below, I’ve outlined the best and worst reasons ‘why’ you should sell an investment.
Why you should sell an investment
1. You’ve reached your goal
This is the best reason to sell an investment – you’ve reached your goal. You are saving money for your children’s university tuition, a home, a car, or you are meeting scheduled withdrawals for retirement. Investments are a means to an end. It’s not about accumulating the most money or adding commas to your brokerage account. It’s about getting to your financial goal. Simply put, you need the cash for your financial goal, so you sell.
2. Fundamental changes to investment attributes
It is rare but sometimes, an ETF or fund undergoes a meaningful change in strategy or increases fees significantly. Since these are key parts of the process to evaluate an investment, a meaningful change may cause you to revisit your original decisions.
3. Your thesis is broken
We all make mistakes and sometimes the thesis for why you bought your investment no longer holds.
For example, you’ve purchased Airbnb because you believe that the company will continue to be at the forefront of alternative accommodation due to a Wide Economic Moat (the company can protect and grow earnings for at least the next 20 years). You may revisit this decision if Airbnb’s faces a backlash and are banned from major markets due to anger over rising housing costs.
Investing is an exercise of predicting what will happen in the future. Sometimes, the prospects for companies change in a negative way.
The purpose of an investment is to achieve your financial goals. If it no longer aligns with what you are trying to achieve you may want to make a change.
There are also several reasons that are bad reasons to sell investments.
Worst reasons to sell investments
1. Short-term performance
This is a classic mistake made by investors. The market’s up 20% over two quarters, and you’ve got a fund that’s only up 10%. Or, the market’s down 5% and your fund’s down 10%. You’re unhappy, but the driver of short-term performance is largely noise. Even the best investors will have periods where they underperform. How an investment performs over the short-term has nothing to do with your long-term thesis. Focus on evaluating the continued applicability of your long-term thesis.
2. Making speculative bets
Investors like to speculate how major events will impact their portfolios and make tactical allocations based on the perceived impact. This often includes selling assets and moving to cash to protect themselves when things feel risky. Long-term investors should remind themselves to zoom out on the performance graph. The market still trends upwards over time regardless of what is happening in the world.
The market tends to price in future known events and quickly adjust when new information comes out. It is difficult for individual investors to react in time to capitalise on this.
Having high quality assets and an investment policy statement (IPS) can provide clarity in turbulent conditions. This will allow you to take a step back as the media and other investors obsess over the news cycle.
3. Fear of missing out (FOMO)
It is human nature to want more. It is human nature to want to maximise your wealth and get the best return possible.
We are driven by fear and greed and these emotional responses are a formula for buying at the top of the market and selling at the bottom. Both individual and professional investors create elaborate models and theories designed to dictate when and why to buy or sell. Despite these models there is still a high probability that investors will panic when the market is going down and fear missing out on profits when it keeps climbing.
These actions lower the returns an investor achieves. This is called the ‘behaviour gap’ - the gap between an investment return and the return an investor gets in the same time period. Constantly switching between investments and assets due to emotional responses has been proven to reduce returns for the majority of investors.
Morningstar’s Mind the Gap study measures the behaviour gap and recently showed the average investors earned 1.2% less than the total returns that their fund investments generated over the same period. This is due to poor timing decisions on investments.
FOMO is a recipe for lower returns, and chances are you’d have better outcomes by just staying invested and logging out of your account.
You are not a professional investor, you don’t need to buy and sell like one.
The media is constantly vying for your attention. One way to get it is telling you which investments are hot and which are not. Many outline what fund managers are buying and selling and their reasons why. It’s important to understand that it’s not always the best idea for individual investors to replicate the process a professional uses.
Fund managers and professional investors are often judged on short-term relative performance. Underperforming an index for even for a year can trigger outflows. The pressure to keep up encourages frequent trading. This is demonstrated through the turnover ratios of popular ETFs and managed funds. Assets are constantly being bought and sold, while the fund’s marketing materials promises a long-term approach. None of these pressures apply to you.
Professional investors are largely indifferent to tax as capital gains are paid by the end investor. This is a major constraint for individual investors on selling. As investors, we need to focus on our after-tax, after-fee and after-cost return. Our net return. Constantly realising gains in pursuit of short-term performance is rarely the path to that outcome.
Trying to invest like a professional often means giving up the biggest advantage individual investors have – time. Knowing when not to sell is just as important as knowing when to sell. Forming strict criteria as the basis of your decision will prevent overtrading and increase returns. Get the foundation right and you’ll increase your confidence that the decisions you make are deliberate and in your best interests.
Invest Your Way
For the past five years, Mark and I have released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.
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