Fund managers are good at buying shares – but terrible at selling them

Buying shares can be tricky. But selling them can be even trickier – even the professionals don’t get it right. John Stepek investigates why, and explains how you can become better at selling stocks and shares.

Investing is a tricky business.

Finding promising opportunities in a broadly efficient-ish market is not straightforward. Doing the legwork to make sure that you haven’t missed anything is time-consuming. And then working out whether you’re paying a fair price or not – there are a lot of moving parts.

Yep, no doubt about it, the buying process is hard. But you know what’s even harder? Selling.

Professional fund managers are good at buying, but terrible at selling

Adam M Grossman, writing on the Humble Dollar blog, highlights a very interesting research paper which has just come out of America’s National Bureau of Economic Research.

It’s called Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors. It’s by Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas and Lawrence Schmidt, and it looks at what is one of the toughest disciplines in investing – managing your selling process.

The researchers looked at a database of buying and selling decisions made by professional fund managers in 783 different portfolios, between 2000 and 2016 (so a decent time period). Active fund managers are often criticised (not least, by us) for generally failing to beat their benchmarks over the long run.

However, what the researchers found is that this is mostly down to one specific part of the trading process.

Turns out that fund managers are actually pretty good at choosing what to buy; the problem is that they lose that edge when it comes to sell. As the paper puts it: “While the investors display clear skill in buying, their selling decisions underperformed substantially.”

And the gap is striking.

The buying decisions significantly beat both the underlying benchmarks, and also a randomised “top up” buying strategy. In other words, when they hit “buy”, the fund managers not only chose the right stocks, but they also got their timing right.

But when it came to selling, they were, frankly, awful: “selling decisions not only fail to beat a no-skill random selling strategy, they consistently underperform it”.

Why is this? From speaking to the managers, the researchers note that: “they appear to focus primarily on finding the next great idea to add to their portfolio and view selling largely as a way to raise cash for purchases.”

In other words, fund managers put a lot more effort into their buying decisions than into their decisions to sell. And this lack of effort ends up being extremely costly in the long run, erasing much of the good work they’ve done prior to that.

How to become better at selling stocks and shares

So what can you take from this as an individual investor?

The first point is that this is one reason why lots of people are better off with passive investing. Active investing takes effort; it’s challenging and the truth is, that’s not for everyone.

You can duck out of these decisions and quite possibly still make more money than your actively-inclined friends and neighbours, simply by putting your money into a small portfolio of exchange-traded funds or tracker funds following the markets you want exposure to.

But let’s say that you want to be an active investor. What else can you learn?

The most obvious point is that selling isn’t harder than buying at a practical level. What makes it harder are the psychological hurdles. Managers simply don’t put as much effort into selling as into buying, and that’s because there’s a very different set of motivations at play.

In fact, the researchers found that when managers put thought into their selling decisions – for example, when they sold out based on earnings reports – they did perfectly well. The real problem is that most of the time when they were selling, they weren’t really thinking about it.

So what does that imply? Firstly – and I think this may well be the most important thing – it’s a good idea to always have a cash cushion in your portfolio. A new idea is always more fun than an old idea; it’s always more exciting. So if you need to sell something to raise money for that new idea, your judgement is already clouded.

The reality is that you want to buy the shiny new thing, so the boring old thing (which may have already made you lots of money and has the potential to make more) does not stand a chance. You’ll engage in as much motivated reasoning as you need to, in order to convince yourself to dump it. That’s how you make mistakes.

Second, approach any selling decision the same way you would any buying decision – do your research. If you’re a serious active investor or stockpicker, then you should have a record of why you bought the share in the first place. Has that rationale changed? If not, then why are you selling now?

Third, as Grossman suggests, consider the asset allocation aspects of your portfolio. Rebalancing rather than selling out entirely can be a good way to take some profits without completely divesting a position that might have further to run.

And given that time is precious, bear in mind that the more money you have in any single position, the more of your time and attention it merits.

I cover more of the challenges of investment psychology in more detail in my book, The Sceptical Investor. I’ll be writing more on this specific study in the next issue of MoneyWeek magazine – if you’re not already a subscriber get your first six issues free here.

Recommended

Which companies will lose the most from the energy windfall tax?
Energy stocks

Which companies will lose the most from the energy windfall tax?

The government’s new energy windfall tax has muddied the waters for investors and companies alike. Rupert Hargreaves explains how it might affect some…
27 May 2022
The MoneyWeek Podcast with Russell Napier at the Library of Mistakes
Investment strategy

The MoneyWeek Podcast with Russell Napier at the Library of Mistakes

Merryn talks to Russell Napier about Edinburgh’s Library of Mistakes, the age of debt and financial repression, plus why he has never invested in Chin…
27 May 2022
Cryptocurrency roundup: another torrid week for crypto
Bitcoin & crypto

Cryptocurrency roundup: another torrid week for crypto

Cryptocurrencies suffered yet another intense week. Saloni Sardana rounds up the week's crypto news.
27 May 2022
Ocado faces a “crunch” year – should you buy or avoid?
Share tips

Ocado faces a “crunch” year – should you buy or avoid?

Ocado was one of the big winners from the pandemic as customers moved online. But now it’s struggling, and losses are growing. So, asks Rupert Hargrea…
27 May 2022

Most Popular

The world’s hottest housing markets are faltering – is the UK next?
House prices

The world’s hottest housing markets are faltering – is the UK next?

As interest rates rise, house prices in the world’s most overpriced markets are starting to fall. The UK’s turn will come, says John Stepek. But will …
23 May 2022
The Federal Reserve wants markets to fall – here’s what that means for investors
Stockmarkets

The Federal Reserve wants markets to fall – here’s what that means for investors

The Federal Reserve’s primary mandate is to keep inflation down, and lower asset prices help with that. So, asks Dominic Frisby – just how low will st…
25 May 2022
Scottish Mortgage Investment Trust has fallen hard. But is now the time to buy?
Investment trusts

Scottish Mortgage Investment Trust has fallen hard. But is now the time to buy?

After a spectacular couple of decades, the Scottish Mortgage Investment Trust has fallen by almost 45% so far this year. Rupert Hargreaves asks if no…
26 May 2022