This is the advice - not quite verbatim - that we've been giving to certain clients. You'd be amazed at how much some people push back against taking profits.
"That one (insert large telecom or utility stock, master limited partnership, or high yield bond fund) has been good to me lately. I like it and I want to hold onto it a while longer."
I understand that logic. I really do. But chances are, by the time you "don't like it" the price will be lower than it is today….
"I like to sell the losers, not the winners - it's just common sense."
You're right, it is common sense. Unfortunately, common sense is not always a lucrative investment strategy. Common sense would have kept you out of the market the past five years. Common sense would tell you that, since you are hearing so much about the stock market being at its all-time high, it must be "safer" today than it was a year, or two, or three ago. It's not.
A safe investment is one which poses little or no risk to your principal - meaning there is a good chance, or an absolute certainty, that you can at least retrieve your original investment back at some point in the future. I would argue that, despite the headline optimism, there is more risk to your principal today than a year, or two, or three ago. Mathematically, there has to be.
The old adage of "buy low, sell high" is fairly difficult to implement if you don't like to sell your winners. After all, in order for a stock/fund/position to become a winner, it has to have gone higher from your point of entry.
Buy low, sell high - It's simple!
The reason a security appreciates is because buyers are willing to pay a higher price than the security's current value. Conversely, sellers - the ones from whom the buyers are buying - may be unwilling to accept a lower price (than where it is currently trading) to sell their shares. In other words, both the buyers and the sellers think the price is likely to go higher. For every transaction there is a buyer and a seller. The idea that what drives a security higher is having more buyers than sellers is inherently false.
What pushes a security all the way to its high point (e.g. Apple at $700 last year) is the phenomenon described above. At some point, though, reality catches up and buyers are not willing to pay even the current market price for a security. And sellers become afraid that they will never again see a higher price to unload their shares.
Remember, there are many reasons - in addition to thinking it has reached its high point - to sell a "winning" stock: 1) taking profits, reducing position size; 2) the need for capital/liquidity; 3) diversifying away from a concentrated position; 4) a change in investment strategy, risk tolerance, or circumstances; 5) taking advantage of stepped up cost basis upon an inheritance; 6) due to price appreciation the stock's current yield may have fallen to a less desirable level; and 7) miscellaneous other factors.
Below is a graphic reflecting the performance of the S&P 500 over the past five years. The arrows are intended to demonstrate the best opportunities to have bought (upward pointing arrows) and sold (downward pointing arrows), using the obvious benefit of hindsight being 20/20. Keeping this in mind, however, do you think the next arrow should be pointing up or down?
Click to enlarge
Now, of course we don't know what tomorrow brings, but successful investing involves taking calculated risks. This means occasionally letting go of positions in favor of others that might work harder for you as conditions change.
Too much turnover in a portfolio can be detrimental to a long-term strategy because of tax implications and trading costs. However, a bit of patience and tactical rebalancing can be extremely beneficial to your portfolio.
A rising tide lifts all ships
We've been hearing a lot about how well our stock market is doing here in the US of late, and we've also been hearing about what a mess things in Europe still are. Take a look at the recent performance of US stocks versus international stocks and you'll see that the international index (NYSEARCA:VEU) has under-performed by about 25% over the past two years. We find that interesting.
Going against the grain
We see an opportunity to rotate some proceeds from our beloved US market and either initiate positions or add to existing ones in these "under appreciated" developed markets abroad.
Now take a look at the US versus emerging markets and you'll see that the EM index (NYSEARCA:VWO) has under-performed by about 30% over the same time period. We find that interesting, too.
So do you need to revamp your entire portfolio? No, but you might consider making some changes. We certainly are.
Just some things to think about…..
Have a great week!
Disclosure: I am long VEU, VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.