People like to win and hate to lose. Basic in the psychology of people who are investing is the idea that if you make money on a position, you have won, but if you lose money, you have lost. You also see silly ideas like “You don’t lose money until you sell.”
“You don’t lose money until you sell.” Bad advice.
I’ve found that I’m subject to the same impulses. When I was younger, I used to sell a stock if I made a certain gain. For example, I would sell if I made $1,000 so that I could “take a safe position or “lock in the gain” and eliminate the risk of the position turning south and turning into a loss. Because I was taking a gain, I had “won,” but if I let the money ride and the stock went back down, I would have “lost.” Chock one up for the “w” column. Nevermind that I had to put the money somewhere else and possibly take a loss there. I was a winner. This behavior meant that I sold my gainers and held onto my losers.
Because I didn’t want to take a loss, which would then mean that I would “lose,” I held onto the losers, waiting for them to at least get back to the price at which I bought them. Sometimes I’d hold them and they’d continue on down until I finally sold them in despair or just stopped looking since they weren’t worth enough to sell and pay the commission. Sometimes they would go back up to where I bought in eventually after a year or two of waiting. Then I would quickly sell because, according to my ludicrous logic, that way I didn’t lose any money. I didn’t “lose” since I got out what I put into the stock. Now, in reality, while I had the same amount of money, perhaps a year or three had passed. Those dollars didn’t buy as much as they did when I invested them, so I was still losing money. Even worse than the loss to inflation, however, was the loss of time. I lost the ability to grow my money over those two or three years in a good stock because I refused to sell a loser. I just ended up even after that time period instead of seeing gains.
After a few years of doing this, selling winners and holding losers, I ended up with a portfolio of stocks I didn’t really want. I’d sold the stocks that were doing well and probably continued to climb. I held the bad ideas and the poorly run companies, selling them if they actually turned around just as they started doing well.
In investing, there is nothing as important as time.
If you’re a serious chess player, you know about something called “tempo.” Controlling the tempo means that you get to choose your moves and your opponent needs to react to what you do. This keeps him or her from being able to do things that you don’t like. Someone set back on their heels all of the time can’t throw an effective punch.
Time in investing is important as well. Investments grow with time, and you make the most during the years at the end when you have the most money. Each year at the end can mean hundreds of thousands or even millions of dollars in additional wealth. At the beginning, when you first start investing, it may seem like you have all of the time in the world, so waiting for a stock to turn around doesn’t matter. Waiting to start investing is even worse. When you’re young and have fifty years ahead of you, you’ll figure it won’t matter if you wait five years to start investing. You’re wrong. At the end, you’ll wish you had just five more years before retirement.
Selling your winners early costs time. Plus, you’ll still need to put that money somewhere, so you really aren’t reducing risk
When you sell, you need somewhere to put that money. If you leave it sitting on the sidelines, you are losing time. You never know when the next huge run-up in stocks will come, and you don’t want to be sitting on the sidelines in cash when that happens. Selling just because you have a gain may mean getting out of a great company just when they are starting a big climb and putting your money into a stock you don’t like as much. You might also be buying a stock ready for a fall because it has just completed a big climb and become overbought.
Another strategy is to take a “safe position.” Here you sell a few of your shares so that you now have gotten out all of the money you invested, leaving a little in case the stock continues to climb. That leaves you needing to move the money you made “safe” somewhere else, putting it at risk again. The other choice is to leave the money in cash and be losing money to inflation each year it is not invested. Why leave a company that is doing well and perhaps you really like to buy into another one that you don’t like so much?
Holding your losers costs time.
Every year you sit holding onto losing positions for them to go back up to where you bought them is a year you could have invested in something that was growing. There are times when a great stock will go through a sell-off, or a company will drop in price as they reorganize and wait for their industry to recover. There are also times when the whole industry or the whole economy declines, causing some great stocks to go down in price. Oil producers are in just this position right now, the good and the bad. These stocks should be held and perhaps your positions added to during the downturn. This is different, however, than holding stock in a company that is performing poorly and will continue to perform badly, waiting for it to recover.
I did this with Cisco stock, holding from about the year 2000 through about 2012, waiting for it to recover and grow. I eventually sold the stock I had bought for about $20 at $30 or so. True, I made a 50% profit, but I should have seen my money double or even quadruple in that period of time. I lost all of that time when I could have been invested in a growing company instead of an old, tired, bureaucratic company whose time has passed.
Churning is costly.
When you sell a winner, you need to pay brokerage commissions (both for the sale and for the purchase of something else). You also need to pay taxes on the gain, perhaps at a rate of 25-40% when you include federal, state, and local taxes. If you stay invested, the money rides tax deferred until you sell. This means your money, even the money that would have been paid out in taxes, compounds. Over a lifetime, this could be hundreds of thousands or millions of dollars. (I use that phase a lot, don’t I. This is a costly thing to get wrong.)
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.