On Selling Out – Part 3
As you know by now, selling because the market is up or because the market is down are the 2 classic mistakes of investing. Those who have not read Part 1 and/or Part 2 of this series might wonder at this point of time if there is ever a right time to sell. Well, if you want the short answer, check out this Nano that I had written at the start of 2022, otherwise read on (you will find the answer in the remaining paragraphs).
In his memo, Howard Marks goes on to highlight a conversation he has with his son Andrew reproduced below.
Howard: Hey, I see XYZ is up by xx% this year and selling at a p/e ratio of xx. Are you tempted to take some profits?
Andrew: Dad, I have told you I am not a seller. Why would I sell?
H: Well, you might sell some because (a) you are up so much; (b) you want to put some of the gains in the book to make sure you don’t give it all back; and (c) at that valuation, it might be overvalued and precarious. And, of course, (d) no one ever went broke taking a profit.
A: Yeah, but on the other hand, (a) I am a long-term investor, and I don’t think of shares as pieces of paper to trade, but as part ownership in a business; (b) the company still has enormous potential; and (c)I can live with short term downward fluctuation, the threat of which is part of what creates opportunities in stocks to begin with. Ultimately, it’s only the long term that matters.
H. But if it’s potentially overvalued in the short term, shouldn’t you trim your holding and pocket some of the gain? Then if it goes down, (a) you have limited your regret and (b) you can buy in lower.
Aren’t these the 2 reasons why many try to time the markets?
Charlie Munger, the vice chairman of Berkshire Hathaway, points out that selling for market timing purposes actually gives an investor two ways to be wrong: (1) the decline may or may not occur and if it does (2) you will have to figure out when the time is right to go back in. Or maybe, it’s 3 ways, because once you sell, you also have to decide what to do with the proceeds while you wait until the dip occurs and the time comes to get back in.
Continuing to Andrew’s answer to his dad’s previous question.
A: If I owned a stake in a private company with enormous potential, strong momentum and great management, I would never sell part of it just because someone offered me a full price. Great compounders are extremely hard to find, so it’s usually a mistake to let them go.
Also, I think it’s much more straightforward to predict the long-term outcome for a company than short term price movements, and it doesn’t make sense to trade off a decision in an area of high conviction for one about which you are limited to low conviction.
Aphorisms like “no one ever went broke taking a profit” may be relevant to people who invest part time for themselves, but they should have no place in professional investing. There certainly are good reasons for selling, but they have nothing to do with the fear of making mistakes, experiencing regret and looking bad (the same goes for financial professionals as well).
Selling an asset is a decision that must never be considered in isolation. Stanford Professor Sidney Cottle’s concept of “relative selection” highlights the fact that every sale results in proceeds. This gives rise to immediate taxes and other issues.
- What will you do with them?
- Do you have something in mind that might provide a superior return?
- What might you miss by switching to a new investment?
- And what will you give up if you continue to hold the asset in your portfolio rather than making the change?
- Or perhaps you don’t plan to reinvest the proceeds. In that case, what’s the likelihood that holding the proceeds in cash will make you better off than you would have been if you had held on to the thing you sold?
Now that you have patiently read the 3 parts, let me give you some of the key reasons for selling.
- Remember I gave you the answer – When you need the money, else as Warren Buffett said, “Our favourite holding term is forever.”
- The fundamentals of the investment (or the entire stock market) have deteriorated beyond a point of no return, or the original thesis based on which you had invested no longer exists. I have seen brokers giving buy /sell recommendations on the same stock 10 times in 10 years. Short Term Price movements clearly take the cake as the worst reason to sell. If you happen to do this, then you must also know that this is not investing but speculation.
- You have found a far superior investment than this one.
- Rebalancing your Asset Allocation: This means your exposure to the stock market has gone far higher than your ability to sleep well at night. Another name for this is Diversification.
While reason (b) and this one both sounds intelligent, they are predominantly the causes of the Behavior Gap (the gap between Investment Return and Investor Return). Additionally, salespeople know reasons (b) and (c) too well and thus use it generously to walk people out of seemingly good investments.
I have written extensively about how timing (and selling to avoid volatility & regret) is one of the biggest mistakes in investing. Almost no one gets it right. You might want to believe that there are these market timing genies (or geniuses) sitting somewhere. They aren’t. The ones who tell you they can do it consistently are clearly the ones who are lying (aka bullshitting).
The magic is that there is no magic. Real Investing is boring and simple (not easy). The secret is Compounding. Time creates Money. As always, we would be wise not to interrupt it unnecessarily (and most of the time it is indeed unnecessary).