The US stock market has surged over the past 18 months, fueled in part by FOMO (a fear of missing out) among investors. While investors can be impulsive when buying stocks, it’s their selling decisions that really trip them up.
Professional investors are proficient in buying stocks, but their selling decisions cause them to underperform benchmarks. This is the conclusion of a recent discussion paper, “Sell ââfast and buy slowlyBy four researchers who examined the trading activity of more than 700 professionally managed portfolios.
Due to poor selling decisions, portfolio managers give up an average of 80 basis points of return each year, compared to a random sell strategy, or the equivalent of $ 80 on a $ 10,000 investment.
The pros of the market are also people prone to some of the same flawed investment decisions as all investors, who tend to “overlook” selling, notes Adam Grossman, founder of Mayport Wealth Management, who wrote about study in a publication for the Humble Dollar website. This study should serve as a warning about the difficulty of trading individual stocks, he told Money. âStick with an index fund if you can because it isolates you from your own maddening decisions. “
How to Avoid Common Investment Mistakes
One lesson from the study is that investors are actually good enough to buy stocks that will outperform their benchmarks, but they just don’t put the same energy into selling.
The study reveals that instead of focusing on the prospects for future returns of a stock, portfolio managers are subject to behavioral biases such as timeliness of information motivating the decision, the weight of the stock in portfolio, past performance or when stressed.
âThey seem to focus primarily on finding the next big idea to add to their portfolio and see selling largely as a way to raise money for purchases,â the study authors wrote.
To make better selling decisions, Grossman advises a four-step plan: treat the sale with as much deliberation as the buy, have a plan with decision rules for selling stocks, think about how each action fits into your overall portfolio and don’t let the size of the investment cloud your decisions.
A sales strategy is just as important for retail investors as it is for professionals, adds Liz Young, head of investment strategy at SoFi. And establishing those kinds of rules to trigger a possible selling decision will also help you control your emotions when the time comes, she says.
âMy # 1 tip is to pick a percentage down and assess the stock only when it’s there,â Young explains. Here’s how this type of strategy plays out in practice: If you set a 20% threshold for losses, that is, the amount that places a stock in a bear market – then you should only re-evaluate your investment thesis at this point to avoid being too active in your portfolio or reacting to short-term factors. âYou can decide that now is not the time to sell and that it is in fact a buying opportunity. “
Plus, you don’t have to sell all of the stocks in your portfolio or sell them all at once. Young and Grossman both recommend a reverse cost averaging dollar-for-sale strategy in which you regularly sell stocks, just like you can when buying.
This type of strategy can be useful if a stock has exploded into a significant weight in your portfolio, because selling all at once can be “extreme,” says Grossman.
And in the event that the stock price fluctuates after your sell strategy is triggered, “averaging dollar costs is a decent way to protect yourself,” Young adds.
Don’t forget about taxes
The impact of capital gains taxes on investment earnings is another important factor to consider in your selling strategy, because a huge gain for a stock in your portfolio may not be the best reason to sell, Grossman says. Rather, you should wait for other triggers in your sales strategy to trigger that decision, he advises.
While the most obvious reason for selling a stock is that you need the money, setting a selling strategy up front can help ensure that these decisions don’t hurt your performance – or lead you to guess the sell one. Once new information has a stock price must rise again, Grossman says. âTry looking at your portfolio through a tidy lens that can tell you when it’s best to sell. “
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