Don’t follow this investment rule if you want to profit in conservative investments
Most investor sayings or rules have some truth or logic or value to them, and that’s why investors keep repeating them. However, their truth or logic may be irrelevant to your goals, and to the conservative investing philosophy we recommend in our Successful Investor newsletter.
Some rules can undermine your conservative investing decisions at crucial moments
The value of these rules or sayings may be psychological rather than financial. However, there is always a risk that they could override your best judgment at precisely the wrong moments, and lead you to do things that undermine your investment success. This is particularly true for investors who follow a conservative investing strategy.
Here’s an example of one such rule that you may have heard lately with stocks that have moved up since March’s market lows: “You never go broke taking a profit.”
This is true only in an extremely narrow sense. The act of “taking a profit” (or selling an investment at a higher price than you paid for it) won’t, in itself, put you into bankruptcy. However, investing success would be easy if all you had to do was avoid going broke.
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Look beyond price in deciding when to sell your conservative investments
When investors ask us about our conservative investing strategy, they often wonder when they should dump a weak stock from their portfolio and replace it with something new.
There is no simple formula for deciding when to sell a weak performer, regardless of whether you follow an aggressive or a conservative investing strategy. But there are some helpful guidelines.
First, you’re never going to sell at the top or buy at the bottom. That’s why we’re so selective about the stocks we recommend in our newsletters. The better the quality of the investments you buy, the less you have to lose by failing to sell.
In fact, regardless of whether you practice aggressive or conservative investing, the quality of your investments matters much more than your skill at selling.
Second, you should be quicker to sell aggressive stocks than conservative investing picks. With stocks we rate as “Speculative” or “Start-up,” it pays to apply our sell-half rule. That’s when you sell half of a stock that doubles in price.
Keep long-term conservative investing goals in view
In our view, your goal as an investor, particularly if you follow a conservative investing strategy like the one we recommend, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meagre profits or losses.
Unsuccessful investors can still make some profits. They just don’t make enough to offset the inevitable losses and leave themselves with an attractive return. If you focus on the idea that you never go broke taking a profit, you may be tempted to sell your best investments whenever it seems the investment outlook is clouding over.
On occasion, you may succeed in selling just prior to a major downturn, and buying back at much lower prices. More often, prices will soon hit bottom and move up to new highs. If you buy back, you’ll pay higher prices. If you had followed this strategy with Canadian bank stocks, for example, you could have missed out on some big gains over the years.
In hindsight, market downturns are easy to spot. Spotting them ahead of time is much harder, and impossible to do consistently. After all, if you could consistently spot market downturns ahead of time, you could acquire a large proportion of all the money in the world, and nobody ever does that.
The problem is that you’ll foresee a lot of market downturns that never occur. All too often, the market-downturn clouds disperse soon after skittish investors have sold. Good reasons to sell do crop up from time to time, of course, even if you follow a long-term conservative investing approach. But “You’re never go broke taking a profit” is not one of them.
Do you currently own conservative investments? Do you have any concepts you’d like to share? Please add your knowledge to our comments section.
Comments
Jim
The problems with thoughtlessly following the advice that you can never go broke or get hurt by taking a profit (in addition to the risk of missing out on possible greater gains in the future) are:
1) You can loose investing capital through capital gains taxation and commissions.
2) You will need to find a better replacement investment for your money.
3 You might find yourself reinvesting in the same stock at a higher price in the future if it continues to climb (which means that you will also be buying fewer shares for the same money).
N.B. Do not underestimate the potential for massive gains on some stocks by thoughtlessly following other careless CNBC advice such as “What goes up must come down.” or “Trees don’t grow to the sky.” Some trees do grow to the sky as do some well-chosen and well-monitored stocks. I have been amazed to see how many stocks have climbed thousands or tens of thousands of percent over a period of decades, and you do not have to rely on just technology and health sciences companies for huge returns. Some very boring companies have also made surprising returns over the decades. There are numerous American consumer nondurable company stocks that have done this with some very steady charts and dividends. There are also industrial companies, manufacturers, and retailers that have done the same thing. Home Depot stock is up close to 400,000% since it came to the market in 1981. And don’t forget to look at some of the long-term returns on some Canadian dividend stocks such as the banks and Enbridge, etc. People are too quick to think of all stocks as quick trading instruments without remembering that some famously wealthy individuals and families have their wealth invested primarily in the stock of a particular company for decades and their children inherit it. Sometimes you will hear a CNBC expert say that a stock (or the market) should be sold (or not bought) because it is high and a healthy 10% correction is needed, but when the 10% correction happens they say that they are now too scared to buy because of the drop! Just remember that “buy-and-hold” does not mean “buy-and-forget” because some stocks do need to be sold — o be bought later or never again.
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The problems with thoughtlessly following the advice that you can never go broke or get hurt by taking a profit (in addition to the risk of missing out on possible greater gains in the future) are:
1) You can loose investing capital through capital gains taxation and commissions.
2) You will need to find a better replacement investment for your money.
3 You might find yourself reinvesting in the same stock at a higher price in the future if it continues to climb (which means that you will also be buying fewer shares for the same money).
N.B. Do not underestimate the potential for massive gains on some stocks by thoughtlessly following other careless CNBC advice such as “What goes up must come down.” or “Trees don’t grow to the sky.” Some trees do grow to the sky as do some well-chosen and well-monitored stocks. I have been amazed to see how many stocks have climbed thousands or tens of thousands of percent over a period of decades, and you do not have to rely on just technology and health sciences companies for huge returns. Some very boring companies have also made surprising returns over the decades. There are numerous American consumer nondurable company stocks that have done this with some very steady charts and dividends. There are also industrial companies, manufacturers, and retailers that have done the same thing. Home Depot stock is up close to 400,000% since it came to the market in 1981. And don’t forget to look at some of the long-term returns on some Canadian dividend stocks such as the banks and Enbridge, etc. People are too quick to think of all stocks as quick trading instruments without remembering that some famously wealthy individuals and families have their wealth invested primarily in the stock of a particular company for decades and their children inherit it. Sometimes you will hear a CNBC expert say that a stock (or the market) should be sold (or not bought) because it is high and a healthy 10% correction is needed, but when the 10% correction happens they say that they are now too scared to buy because of the drop! Just remember that “buy-and-hold” does not mean “buy-and-forget” because some stocks do need to be sold — o be bought later or never again.