As an investor, it’s inevitable that you’ll be faced with one tricky dilemma: when, exactly, do you cut your losses?
I touched on this last week, when we looked at the dangers of selling low – and since this issue is so key to the investing game, I’m going to talk about it again now.
Selling a stock is much more difficult than buying one – especially a loser. Whether it’s pride or hope, there are plenty of psychological obstacles in your path.
It really requires a dedicated action plan. And that’s what I’m going to focus on today.
When it comes to selling up, there are a few simple changes you can make to your method that I guarantee will put you way ahead of the pack.
Every investor’s must-have tool
So, where do you start?
First and foremost, you need to take control of your portfolio.
What do I mean by that? Well, like most investors, you probably use online valuation tools to monitor your portfolio. If not that, then the regular valuation reports that drop through the letterbox.
And that’s all well and good. Only problem is, these valuation statements miss a heck of a lot of information – not least the reasons you bought the stock, and any associated yardsticks that may indicate your exit route.
That’s why you should consider making your own notes.
As a youngster, I did this using an accounts ledger. These days I do it all on a spreadsheet. It doesn’t matter which way you do it, and there’s a wide scope for what you include too.
The following shows an example of an entry you could’ve made for Tesco:
|Date||Company||Source||Price||Expectations||Other thoughts||Expected price|
|Jan-14||Tesco||Daily Telegraph||£2.60||2015 indicators:Revenue: £62.6bn Profit: £2.45bn Dividend: 14p||Sentiment reversal. Catalogue business growth. Convenience store growth 20%. Online sales growth 10%. Bank business 25% growth||£3.50|
This is very much a basic example – it’s the minimum any serious investor ought to include.
It’s got the date, the stock, the tipster, what you expect to happen, and the sort of exit price you might consider.
Why bother noting all this down? Because without this reference data, there’s no way of judging success or failure.
Without it, it’s all too easy to be buffeted into making a sale just because the price moves against you. Or for that matter, if you’re in the ‘when in trouble, double’ brigade – it’s all too easy to double your exposure to a loser.
And my ledger entries go much further than just the basics.
Ask yourself all the right questions
In my own notes, I always include a column assessing my thoughts on management.
Are they building trust, or destroying it? If they’ve made mistakes, how many more am I willing to take? The City adage is that profit warnings usually come in threes – are you willing to wait that long?
On some stocks, I’ll lay down a timeline of how long I’m willing to give the company to achieve my goals (not theirs!).
Key indicators could include number of new contracts, growth in client revenues, cost cuts – those sorts of things.
Many investors forget all about the fundamentals of investing along the way. It’s easy to use a stop-loss to trigger a sale without even thinking about it.
But does that really make sense? I mean, if you entered a position on the basis of a fundamental valuation, shouldn’t you use the same analysis for your exit?
And once you’ve asked yourself these key questions, there’s one more thing to do.
The private investor’s key advantage
When news comes out on a stock in your portfolio, I’m sure you’d agree that you ought to be the first to know about it.
Well, that’s simple enough to set up. These days it’s easy to subscribe to an automated notification service – and you should be doing that, at the very least.
When the releases come through, it’s important not to make a knee-jerk reaction. Take a break from what you’re doing (if possible!) and take a long, hard look at the regulated news release (not some newspaper interpretation). Ignore the introductory pointers – read the whole thing!
Private investors have a great benefit at this stage. For sure, many in the City will react immediately to the news release, but for the vast majority of investors, it’ll take time for the information to sink in.
Analysts will reflect on the news and write a note. Fund managers will learn about it all in tomorrow’s FT. Many won’t have a clue until the situation is discussed in the next investment strategy meeting.
As a private investor, you shouldn’t have more than one or two dozen stocks to look after. Or at least, if you keep on top of selling the losers, you shouldn’t have! That means your reactions should be lightning quick.
But more than reacting to events, one should schedule a monthly, or quarterly investing strategy meeting with yourself and your ledger. Have a planned format and tackle each open position. Look for the exit routes!
Be smart – learn when to get out of an investment
This may all sound like it’s going a little too far. But in reality, the ideas I’ve laid out above are the only things we’ve got to go on when judging the merits of our investments.
Without documenting our thoughts, our hopes, or even our dreams – then how can we know when it’s time to close the position down?
As with gardening, pruning is the key to a fruitful investment portfolio. Leave the pruning too long, and it’s going to get messy. And I’m sorry – but this is one job that you’ll have to do on your own.
Set up a system, and you won’t go far wrong.
• Given the importance of selling, I’m often asked why I don’t follow my investment ideas right through to the sell action too. And the answer is: it’s just not practical. For starters, the timings will be all out of kilter.
Also, everyone gets into a position for their own reasons. Some investors pick up on a dividend yield. Others the exciting growth story, or perhaps a turnaround strategy. In the same way, it’s a unique set of circumstances that provokes a decision to sell.
That’s why it’s critical that you formulate your own, unique sell-side diagnostic.