Every investor faces a whole host of challenges in managing their portfolio. Chief among them: deciding not only when to buy, but also when to sell. This is critical when you’re taking profits and when you’re cutting losses.
One of the greatest mistakes in portfolio management is in selling to take profits whenever those profits materialize. There is nothing wrong with taking profits, but realistically not every issue will become profitable. A balancing act helps keep your portfolio in balance, as well.
Just as important in profit taking, meanwhile, is determining when to sell stocks whose market value has fallen, so that you can avoid further losses. Loss-reducing decisions keep your capital robust and working. Imagine a portfolio in which you sell only when stocks become profitable. The end result is that you end up with a portfolio full of issues worth less than they were when you bought them. The attrition of profitable stocks leads to a negative selection process.
To avoid this, it is essential to cut losses. Three suggestions:
1. Match winners and losers
If you are going to take a profit today, also check to see if you have issues that have lost money. If you take both the profit and the loss at the same time, you accomplish two advantages. First, you free up more capital to reinvest in other stocks. Second, the loss offsets the profit and helps keep your tax liability down.
2. Identify both a profit-taking and bail-out price in advance
Before you even buy stock, decide in advance when you will sell. This works in both directions. For example, you might decide to sell one-half of stock if and when the value grows by 75%. In this manner, you take profits on a portion of your holdings while leaving the other half to keep growing. At the same time, you may decide to sell all of a stock if its value falls by 25%. This cuts your losses and frees up capital.
These price points can be programmed in advance with stop orders or trailing stops, types of sell orders worth looking into.
3. When you take a loss, don’t dwell on it. Move forward
It is easy to get shy about taking losses. No one enjoys making mistakes, especially when they cost money. But realistically, you are never going to get 100% profits in your portfolio. Learning to accept losses as part of the course of investing is a sign of maturity. Successful investors learn from their mistakes, and do no stay out of the market fearing further losses. Trust your instincts and always buy based on sound criteria. This improves your success ratio over time.
The Bottom Line
No system is foolproof; but one mistake a lot of investors make is taking profits without also taking losses. To avoid ending up with a portfolio that has depreciated below your original value, match up profits and losses; set sell price points in advance; and never dwell on those decisions that go south.
Of course, we learn from our mistakes, but that doesn’t make losing any easier. However, the smart course of action is to keep your perspective, learn from your positive and negative experiences, and always make buy decisions based on sound, sensible fundamental choices.
Michael C. Thomsett is the author of over 60 books, including Winning with Stocks and Annual Reports 101 (both published by Amacom Books), and Getting Started in Stock Investing and Trading (John Wiley and Sons). He lives in Nashville, Tennessee and writes full time.
3 Ways to Avoid The Most Common Investing Mistakes was provided by Minyanville.com.