Quick! Take a peek at your investment portfolio. Don’t worry, I’ll wait.
Now imagine all those fun tickers aren’t there. No little green or red numbers or arrows. You don’t have any holdings. No stocks, bonds, mutual funds, ETFs, options, swaps, foreign currencies, listed REITS, non-traded REITS[i]. No annuities [ii]. No commodities.[iii] Just cold, hard cash.[iv]
Would you build the identical portfolio you own today anew? If your answer isn’t yes, then you may have a problem—a problem that, in my experience, is much more common than you might think.
Markets look forward, not backward, so the decision to hold something today should be made in anticipation of the future. Based on a forecast or outlook, that is. When buying, most folks get this to some extent, in the sense that they at least presume the investment:
1. Has a future.
2. They want to be part of that future.
Now, past price movement has no bearing on the future, so your #1 and #2 shouldn’t hinge on whether a stock has been rising[v] or falling a lot, a fund’s trailing performance or other pure performance-based rationale. There should be an answer to the question, “Why?”
The choice to hold a stock is the same as the decision to buy, because it says you (still) want to be a part of that investment’s future. But all too often, I find investors get caught up in noise, like deciding to hold because of recent past performance, or allowing some other emotional factor to sway their decision.
For example, many individual investors I’ve talked to about their portfolios over the years have told me some variation of the following, “I am holding <<Insert Investment Here>>…”
a. “…until it comes back to my purchase price.” (Break-even)
b. “…because it’s on a tear!”
c. “…because it did really well over some past period of time.”
The trouble with these should be clear: None are about the future; all are about past price movement.
The first one is perhaps most common. Any investor who has been in markets for more than the blink of an eye has seen something they bought go down. And that’s ok! Perfection isn’t a reasonable expectation. But when this eventuality happens to you, the correct practice is to assess whether the reason you own the investment has changed. If not, then you don’t seem to have much reason to sell. Holding may be the right move. However, if it has changed—like if the tech firm you bought shifts from making computer chips to potato chips—then you have a pretty good reason to sell and put the money to better use elsewhere. Or if you realize that variable annuity you own is in fact a variable annuity (likely loaded with astronomical fees), you may have a very good reason to sell.[vi]
Waiting for a price to rebound to break-even, however, isn’t a viable rationale to own something. It may feel better to sell something when it’s in the black and not red (or less in the red), but there is no guarantee that bounce comes. Or that you couldn’t get a far bigger bounce by selling and buying something different! By fixating on the past return in this down stock, you are unwittingly creating a false either/or: Either you hold until it bounces or you lock in a loss. But you only lock that loss in if you don’t invest it in something else! Simply holding for break-even shuns the opportunity to do something better, something more cohesive and thought out. Something actually forward looking.
Another, non-past-performance-related reason folks cling to stocks they wouldn’t buy back today is emotion. Maybe the company is your former employer. Maybe you inherited the position. Maybe it’s a local company you’ve known all your life. While I can understand that emotional ties exist, investing is about making decisions regarding the future of a business. These emotional ties should be mitigated, if not outright eliminated. That doesn’t mean you necessarily sell. It does mean your reasons to own an investment should probably not include something purely emotional, particularly if these holdings comprise a large share of your portfolio.[vii]
I realize there are times when it may be best—or the only possible course—to own certain stocks based on something past. If it is restricted, this is an obvious exception. Giant embedded gains may be, too, but the key here is to plan for it. However, these scenarios just aren’t the rule.
If you hold stocks based on past movement, you wind up with a portfolio built for yesteryear, one that stocks have moved far beyond. One lacking an overarching theme or strategy! In my view, if you wouldn’t build the exact portfolio you own today, then it is incumbent on you to ask why. The current state should never get in the way of what you view as a more ideal state.
[v] This is known as momentum, which is a real thing in physics, but not investing, in my view. And it is a poor way to select stocks, because if the stock falls, your reason to own is eliminated, meaning you should sell. That means your strategy, if you follow it to the letter, is to buy stocks after they rise, and sell after they fall. Not exactly a golden road.
[vi] A transaction that will also probably be loaded with astronomical fees, depending on when you bought it, which is like reason number infinity not to buy them.