Why we find it so hard to sell our stocks and funds
Posted by: Uma Shashikant on Jun 18, 2018, 06.30 AM IST
A common problem in many investor portfolios is the holding of too many stocks, bonds and funds. When we make a choice, it is not always with high conviction, for we worry about how it will turn out. Thus we have small amounts invested in a long list of investments. Then, we subconsciously seek information that confirms the merit of our holdings. Soon enough inertia sets in. We like what we have, and can’t find a fault to make a change. Thus we end up with a portfolio that has not been pruned. We simply can’t let go and sell.
Selling is a tough decision, though conceptually it need not be so. We buy from the whole universe of stocks and funds, but we only sell what we already have. In that sense, the subset that we have to evaluate is smaller and well defined. But that does not make our decision easy. There is a combination of fear, hope, regret, reconciliation and ownership at play.
To sell is to severe the relationship with that stock or fund. It seems like a final decision where we won’t turn back to see what happened after. But the pain of selling and seeing the stock soar soon after is horrible. We think that there is a lot left in the investment and holding on is a better decision. There seems to be a nice and virtuous note to being a long-term investor in what we have chosen. So how do we make the decision to sell?
First, our evaluation of what we have in the portfolio, performed with some diligence and care at least once a year, should be about the future potential of our holdings. If it is not worth buying at the price we see today, it may not be an ideal candidate for holding either. Would we buy more of it today? Would we recommend to a friend today? Would we increase our holding of the stock at today’s price? Would we stake an amount equal to its value now? If the answer to these questions is not a firm yes, the investment in question is underperforming. Its own absolute merit is low. Such investments need selling.
Second, if we refuse to sell because the current price is lower than the price at which we bought the share or the fund, we are victims of a psychological trap. The price of a stock will go up and down based on its own fundamentals and technical factors in the marketplace. The price at which we bought it is a marker only in our head; it is not a watermark of any kind at the market. No one else cares, really. To think that we will quit only at a profit, or when the price is even, is to ignore the realities of the market. To sell is to evaluate an investment for its place in the portfolio as a whole. It is not possible for every investment choice in your portfolio to be a winner.
Third, we have a target in our mind which we set for an investment, and decide we will sell when that is reached. Many investors have thumb rules that ask for the stock to double, and for the investor to quit with discipline at that point. Price targets are a good stance for traders, who can take losses easily as part of their tactic at the markets. For long-term investors, such targets may not work. Each investment we have should ideally have an investment thesis, or a set of reasons for which we bought them. Selling should align to those reasons, and get triggered when those expectations are not met.
Fourth, investors are guided by this notion of booking profit. They like to think that a stock that is running up might correct, and it is wise to take some money that is on the table. The problem with this thinking is that it does not allow a winning position to run to its full potential. In a rising market, the focus should be on the downside, as the upside potential is quite unknown. An investor focusing on cutting losses will be better than one who is focused on booking profits. A better approach is to focus on contribution of each holding to the portfolio’s total growth. Investments that are contributing the most should be allowed to run, while those that are doing little, or taking away the profit due to poor performance, should be nicked. Having a ‘stop loss’ point is more important than having a ‘book out’ point in price.
Fifth, every selling decision triggers an emotion, and we prefer to feel a sense of victory rather than a sense of regret. When given a choice to sell, we would rather sell what is performing and feel happy about the profits we booked. Behavioural scientists have extensively documented our tendency for loss aversion, where we will sell winners rather than losers. We can manage this somewhat by making the decision a paired one – the stock we are selling and the stock we are buying with those proceeds. In a gradual manner if we are able to see how the shifting of money is working in our favour, we may be able to implement this decision.
Sixth, the burden of selling is not just about regret but about the decision to redeploy the funds thus generated. When faced with the choice of too many alternatives, the decision to reinvest seems burdensome. There is the fear that what we sold will soar, and what we buy will fall, making it a double whammy of a wrong decision. Taking a portfolio view of what we hold, and taking an investment universe view of what we can buy, is a better approach. If our investment style is one that purveys what is available, and selects them for their merit, then our selling decision becomes one of finding funds. When we are able to see selling as a strategic decision in the portfolio, where we are moving things around so as to accommodate new and better investments, we will be able to own that decision better.
Many investors are surplus savers, who tend to deploy fresh money, and typically use it to buy something they don’t already have in the portfolio. This approach makes the portfolio unwieldy, and ends up with good and bad holdings over time. Just as weeding and pruning are in the interest of the overall productivity of the garden, selling should be seen holistically.