Just as a basketball coach relies on their playbook to navigate high-pressure moments, this column explores the frameworks, principles and behaviours that help investors make better decisions in their investment journey.

In my last edition, I covered three simple questions to ask before buying a new investment. This week I want to flip the script. One of the most difficult and consequential decisions investors face isn’t always what to buy. It is when to sell.

Portfolio outcomes are weighted by both investment selection and the timing of trimming or exiting positions. Every holding occupies capital and influences the overall risk and return profile of a portfolio.

Yet many investors solely focus on valuation, recent performance or the macroeconomic backdrop when selling.

While these factors play a part, investors must also have a framework to guide decision-making. A thoughtful approach to selling should also acknowledge the financial objectives of the wider portfolio.

Before deciding whether to trim or exit an investment, run your thesis through the framework below. These three questions can help bring structure to one of the most difficult decisions investors face. But first, why is selling so difficult?

A difficult dilemma

The art of selling is far more difficult than many investors realise. In a 2018 study first highlighted in an article by Mark, researchers found that institutional investors with hundreds of millions of dollars under management consistently made poor selling decisions.

While their expertise in purchasing stocks added value, the securities they chose to sell often went on to outperform those they retained. In fact, the research found professional investors would have achieved better outcomes by randomly selecting what to sell.

Other examples of behavioural research highlight the complexity of selling. Studies on the “disposition effect” found investors are more likely to sell winning investments early while holding onto losing positions for too long.

Even the most seasoned investors struggle to make good selling decisions. Individual investors should be wary of relying on instinct or valuation metrics alone when selling.

No single framework can guarantee you’ll get every sell decision right. However, it can ensure your decision making remains aligned with the objectives you’re trying to achieve.

Has your original thesis changed?

This is the first question investors should ask before selling. Every share or ETF should be purchased for a reason. The purpose of the particular investment might be generating income, delivering capital growth, providing diversification or gaining satellite exposure. But you should also have a thesis why this particular investment will serve its intended purpose.

Before making any sell decision, revisit that original rationale and assess whether it still holds today.

Let’s say you build a portfolio of sustainably growing income shares. The purpose for doing this is to meet your financial objective of creating a sustainable source of growing income. That is what each holding should be working to achieve.

The next step is finding companies to buy that meet your specific criteria. In our example the key signals to look for could be defensive earnings, economic moats and a history of the company growing payouts to shareholders through the cycle. That is the underlying thesis behind each investment, all working towards the broader goal.

A company in your portfolio may shift capital away from growing its dividend and towards investing in new businesses. This creates a crossroad for the investor. Do you stick with this business or do you sell and allocate the capital elsewhere?

Without a clear thesis for owning the shares, it’s no surprise many investors find selling decisions difficult. Instead, revisit this thesis which is backed by the overarching portfolio objective. The answer is likely to be much more apparent.

This principle is the same for ETFs. The only difference is there tends to be less change over time due to how the funds are structured (ie. index based ETFs). In a portfolio of ETFs, investors should assess the original decision to own each individual fund. It is also important to be aware when ETF providers change strategies.

A good example is when an investor purchases a thematic ETF as a “diversified punt” in a sector they are bullish in. This may make sense at the time but the overlap between underlying holdings in these ETFs may blur the lines of the original objective.

Does it still earn a place in the portfolio?

This question builds on the first.

A change in the original reason for owning an investment doesn’t always mean it should be sold. Both your investments and your financial goals will evolve and change over time. The real test is whether the investment still earns its spot in your portfolio now.

I am personally a long term, growth-oriented investor predominantly invested in shares.

My primary portfolio objective is achieving long term capital growth over a 30+ year horizon.

To get there, each company I own should reflect high-quality, well-run businesses with moats typically early on in the business cycle. The reasoning behind this is because I have a longer runway for growth and can afford to accept greater share price volatility over the short to medium term.

Based on these objectives, the tests I run on individual shares in the portfolio evolve around company management and if their own long-term objectives align with mine. If that alignment changes or management takes the business in a direction that no longer supports my thesis, that becomes a signal to update my exit strategy.

This requires me to first revisit my original thesis, then test that thesis on the information I have available to me today.

Of course, your own thesis will be different to mine, as each investor has their own unique set of goals with investing. However, the same testing process is the same.

Ask yourself, are the investments you picked working as hard as it can towards your specific financial objectives?

Is there a better use for your capital?

The first two questions established whether an investment aligns with the portfolio objectives and earns its place.

The final step is to consider the true opportunity cost of selling.

This is the idea that every dollar invested in one asset is a dollar that can’t be invested elsewhere. While it seems simple on paper, the implications for investors are more complex.

Consider two investments. The first is a quality share you own that has served you well for years. The second offers stronger fundamentals, a more attractive valuation and a higher probability of helping you achieve your end goal.

The challenge for investors isn’t just recognising the better opportunity. It’s being willing to part with an investment they already own. While on paper the answer on what the investor should do is straightforward. In a frictionless world where markets trade freely, the investor would rationally switch to the new share.

However, we are not in a frictionless world. The decision to sell a share becomes increasingly difficult when considering tax implications and transaction fees.

Many old legacy holdings in portfolios have generated substantial capital gains through generations. This creates logistical headaches for the investor and many find it easier to hold instead of switching.

One way to overcome this is to incorporate the friction costs into your consideration. Compare alternative options in the market with an additional premium, which is the friction costs that come with selling your current investment such as the associated taxes.

Incorporating these considerations into your framework will help you avoid making a costly decision down the line.

Wrap up

The art of selling is more nuanced than many investors realise.

I challenge investors reading this to consider incorporating a framework specifically for selling investments.

Ask questions like what was the original thesis for owning the investment.

Assess whether it still earns a place in your portfolio.

And finally consider whether there is a better use for the capital after accounting for real world costs.

By incorporating a simple decision-making framework, investors can bring greater discipline to one of the most difficult decisions in investing.

No framework can eliminate mistakes entirely. But it can help ensure sell decisions are driven by purpose rather than emotion or short-term market noise.

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