Overview – Selling an Investment is Part of the Process
So often investors are told that the “secret” to investment success is to hold onto their investments for as long as possible in order to let them grow indefinitely. Some pundits even go so far as to endorse an “invest and forget” approach.
While holding onto investments for the long term is the cornerstone of many strategies, this approach makes a very bold assumption: that the investments in question never lose their merit. Any reasonably experienced investor knows that this isn’t true at all.
One of the realities that all investors need to accept is that investment merit is malleable. An investment that seemed very lucrative today may prove to be a burden on your portfolio later on. Time and time again, history has demonstrated that even the most seemingly robust investments can one day lose their luster.
Knowing when to let go of a bad investment is just as important as knowing when to seize an exceptional one. However, before deciding to sell there are some things investors need to understand, as well as some questions they may want to ask themselves before proceeding.
Loss Aversion: The Reason Why Selling an Investment Can Be Difficult
Imagine you just won $10. Free money is always a welcome surprise, but chances are you aren’t going to be shedding any tears of joy (unless you desperately need the cash). You’d likely accept the money and simply move on with your day.
Now, imagine you stand to lose $10. Maybe you need to buy something from a convenience store or you have to take an unexpected Uber ride. Even if it’s just $10, it probably doesn’t feel good having to suddenly give that money up. The thought alone of unexpectedly losing $10 is probably enough to sour your mood.
Most people have a stronger emotional reaction to the possibility of losing something as opposed to the possibility of gaining something. In the world of psychology, this is known as loss aversion.
Loss aversion is a cognitive bias that states that the pain of loss is psychologically twice as powerful as the pleasure of gain – interestingly, this is true even if the quantity of the thing you stand to lose/gain is the same.
This cognitive bias is arguably the reason why many investors have a hard time selling an investment, even if they know that it’s in their best interest to do so. For some investors, the pain of loss, no matter how minimal it may be now or in the long run, is too much to bear.
Very few investors would probably bat an eye if their portfolio suddenly increased in value by $100, but the prospect of needing to sell and taking a $100 capital loss in the process is, for some, too painful to deal with, even if the loss today pales in comparison to the future losses that will be sustained by not selling right now.
Anytime psychology and investing clash, there are usually no easy solutions to follow – dealing with loss aversion is no different. The best an investor can do is to stay as rational as they can and to remember that dealing with a small loss today is nothing compared to the future gain they may one day reap.
Selling After Careful Consideration vs. Panic Selling
After an investor has overcome the mental hurdle of loss aversion and is now prepared to sell, there’s another hurdle they’ll quickly encounter: Are they selling an investment because it’s the logical thing to do based on their analysis, or are they doing so because of some emotionally-charged short-term panic that’s currently going on?
Before deciding to pursue an investment operation, any competent investor will first take the time to perform thorough analysis, weigh their options, and then finally make a decision. This is a process that takes time to complete, not something that happens in the blink of an eye.
If investors are this meticulous before deciding to buy, then they have no reason not to be just as meticulous before they decide to sell.
Selling an investment is a big decision – make the wrong call and you may end up letting go of an investment that shouldn’t have been let go in the first place.
One of the worst things an investor can do when deciding to sell is to do so simply in response to short-term panic. Time and time again we see countless investors do this whenever any sort of bad news appears, whether it’s a trade war, a new virus, or the start of some armed conflict.
The vast majority of investors who choose to panic sell aren’t doing so because they performed lightning-fast analysis and decided that it was time to divest, but rather because they saw everyone else doing so and decided that the best course of action is to simply follow the crowd.
Investors who choose to panic sell run the risk of doing something that may end up causing them more harm. Remember, choosing to do nothing is a valid option – just because you take lots of action doesn’t mean all your problems will be solved.
So, if you ever find yourself contemplating the idea of selling an investment, ask yourself if your decision is a result of careful thought, or if what you’re doing is simply a knee-jerk reaction to what’s currently going on around you.
Some Questions to Ask Before Deciding to Sell
There are a seemingly infinite number of questions an investor can ask themselves before deciding to sell. After all, as we discussed earlier choosing to let go of an investment isn’t a decision that should be made lightly.
Although we can’t possibly hope to cover every single question an investor may want to ask themselves, we’ll go over a few examples and the thought process behind them.
Ultimately, the specific questions an investor asks themselves aren’t that important. Instead, what matters more is to get their critical thinking going and to make sure that the decision they’re about to make is as informed as possible.
“Is Selling Really the Best Option to Pursue Right Now?”
Although selling is a serious possibility that investors may one day need to consider, this doesn’t mean it’s always the best option to pursue every time it comes to mind.
Remember, the decision to sell should always be one that’s backed by lots of careful consideration, and part of that consideration is to evaluate all your potential options.
If you believe that selling is the best course of action, then why is that? What exactly will you accomplish by letting go of a stock, bond, REIT, or ETF that you’ve held for so long? Are you truly letting go of something that’s burdensome to your portfolio, or are you simply living through yet another period of short-term volatility that will soon pass?
Maybe, because the price of the investment you want to sell is low, it would be best to use this to your advantage and increase your stake instead. Perhaps the investment merit is still strong but you’re being distracted by others to panic sell when instead you should be contemplating the possibility of buying.
Just because the prospect of needing to sell comes to mind doesn’t mean it’s the first option you need to go with.
“How Exactly Has This Investment Lost Its Merit, and to What Extent?“
After making sure that you’re selling an investment not because you’re panicking but because it truly has lost its merit, the next step is to determine how badly the investment’s merit has deteriorated.
Was this investment previously one of your superstar holdings and is now dragging your portfolio’s performance down by quite a large margin, or is it an investment that, despite having lost quite a lot of value, makes up only a small portion of your portfolio?
Part of any damage assessment is to understand the extent of the damage that was done. If you have no idea how bad the damage is, then it’s very difficult to determine how extensive the fixes need to be.
Imagine your house recently caught fire. You know that repairs need to be made, but to what extent? A burnt yet relatively intact room is one thing, but needing to completely rebuild several rooms because they completely burned down is an entirely different story. The process of rebuilding your burnt house starts by understanding how bad the damage is.
Selling an investment is no different: if you know that an investment has lost its merit, then the next step is to determine how badly this has impacted your portfolio. Producing a satisfactory answer to this question is critical to answering the next one.
“How Do I Plan to Compensate for This Investment That I’m About to Sell?“
After finally deciding to sell and once the sale has been completed, this doesn’t mean an investor’s work is now done. Another thing investors need to worry about is how they plan to compensate for the hole left behind by the investment(s) they just sold.
Imagine you have a portfolio worth $50,000 and you just sold your stake in an investment that was worth $10,000. That’s 20% of your portfolio’s value now gone in the blink of an eye.
How do you plan to recoup that $10,000? Do you commit more capital to your existing holdings, or do you look for new investments to fill in the gap?
Unless your intention was to reduce the overall value of your portfolio, then you’ll need to know what your next steps are after selling to fill in that gap. Without a plan in place to compensate for your sold investments, your portfolio will gradually become smaller and smaller every time you decide to sell, which could prove to be a hurdle to reaching your desired investment goals.
Understanding the Short and Long-Term Consequences of Selling an Investment
We’ve talked about the importance of long-term thinking before, and why it’s important to seriously consider the immediate and future consequences of your actions. By hyper-focusing on the present, you run the risk of potentially jeopardizing your future.
Up until now, we’ve talked about the importance of making sure that, when selling an investment, you do so after carefully thinking things through. If done correctly, it could spare your portfolio from further damage, but if this decision is made hastily, you could cause even more, unexpected damage to your portfolio.
While the importance of rational decision-making can’t be stressed enough, it’s important to remember that the decisions you make also have immediate and future consequences: choosing to sell an investment is no different.
It’s easy to panic sell to try and alleviate short-term stress, but many panic sellers fail to think about the future consequences of their actions. Maybe they just let go of a high-quality investment that will never go up in price again, or perhaps the investment they let go will go on to become a prominent blue-chip stock within the decade, with gains that far exceed the relatively small losses sustained when the investor decided to sell.
Choosing to sell an investment comes with its fair share of short and long-term consequences, for better or for worse. It’s important for investors to assess what these consequences may be, and to make sure that they’re willing to accept them.
Nobody knows with certainty what will happen in the future, but that’s not the point of long-term thinking. Rather, the idea is to force someone to stop and make sure that what they’re about to do doesn’t have the potential to come back and bite them in the rear someday.
Wrapping Up
Selling an investment is an action most investors may one day need to consider. If investors are highly meticulous before deciding to pursue an investment, then it makes sense to apply the same level of diligence before deciding to sell. After all, one bad buy or sell decision can lead to some very serious damage to your portfolio.
Therefore, before deciding to sell, there are a few things investors may want to ask themselves to ensure they’re making the right call.
“Am I selling because it’s the logical thing to do?”, “Is selling really the best option to pursue at the moment?”, “How do I plan to compensate for the investment(s) I will sell?”
Regardless of what questions an investor chooses to ask, the important thing is they get their critical thinking going to make sure that what they’re about to do is the best option possible. Every decision comes with short and long-term consequences, so when deciding to sell, an investor better make sure that they’re prepared to face whatever consequences their decision may entail.
