Investors often go for the easy gains, but resist the urge to dump your best stock picks for a quick profit

Here’s a quote from one of the first highly successful investors I ever had the privilege of meeting. While talking about the stock market, he casually mentioned, “I’m a rich man today because I was smart enough to buy Canadian Tire stock at $0.50, and too stupid to sell when it hit $2.00.”

The quote deserves to be repeated more often, since it simplifies a key rule for successful investing and preserving your best stock picks: Don’t be too quick to sell a winner. Unfortunately, this rule gets broken all the time.

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Many investors buy a particular stock, often a junior stock, because they like a number of things about it: the business plan, the experience and achievements of the management, the outlook for the industry the company is targeting, the general economic environment, and so on. Before too long, however, other investors are likely to discover the same stock.

They may like it so much that they bid up its share price. When that happens, it can spur the early buyers to take profits.

These early buyers may lose interest because they fear the stock has burned up its near-term potential. Worse still, they may fear the rise is a “last gasp” and that the stock may suddenly go into a deep setback. Or, they may decide they found one good stock before the rest of the market did, so they can sell their latest winner and go on to invest the proceeds in something better.

Their initial good fortune may give them the urge to sell their first winner, in hopes of finding something else just as good, but with more profit potential because it has not yet caught the market’s attention.

Before you yield to this urge, it’s better to consider what else has changed about the stock, other than its rise in price. Did its business plan change? Probably not. Chances are that few if any of its attractive industry aspects have changed. Good management, good industry opportunities, a positive economic outlook and so on can persist through long periods of adversity.

That’s why you need to overcome the intermittent but all-too-human urge to take a quick profit on your best stock picks.

Mind you, before selling the stock and buying something else, you need to contemplate a related rule: Resist the urge to declare a junior investment a winner, just because of its novelty, or its uniqueness, or its frequent appearance in the broker/media limelight.

Lots of good-sounding investment ideas turn out to be poor investment performers.

Think long-term when it comes to maximizing gains on your best stock picks

The goal of an investor, particularly if you follow the Successful Investor approach, 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 investment belief 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’ll never go broke taking a profit” is not one of them.

So, when is it the right time to sell your best stock picks?

Investors often ask, “When do I sell?” There is no simple, fits-on-a-t-shirt answer to the question. But there are some helpful guidelines.

First, you’re never going to sell stocks at the top or buy at the bottom. As Bernard Baruch said, “That can’t be done — except by liars.” That’s why we’re so selective about our stock market recommendations. The better the quality of the investments you buy, the less you have to lose by a failure to sell.

In fact, regardless of whether you are an aggressive or a conservative investor, the quality of your investments matters much more than your skill at selling.

Second, you should be quicker to sell aggressive stocks than conservative stocks. 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.

Third, when a stock you own is getting taken over, it usually pays to tender to the takeover. That way, you get the full takeover price and you don’t pay brokerage commissions. Selling one month ahead of the takeover can cost you, say, 3%. On annualized basis, that’s like missing out on a 40% profit.

Many investors mistakenly assume that frequent profit-taking is the key to long-term success. Few brokers disagree, since they make money every time you buy or sell. But in the long run, taking profits simply because profits are available is going to cost you money. That’s because of the way the stock market works.

Stock prices rise 10% to 12% a year over long periods, on average, but individual cases and years vary widely. Even good stocks sometimes go sideways for decades, while others turn out to be ‘ten-baggers’ with gains of 1000%. To make serious profits, you need to hang on to your best performers for years. If you are too quick to sell stocks that have gone up, you may avoid some 20% setbacks, but you’ll also miss out on some 200% gains.

And as that one successful investor told me long ago, “I’m a rich man today because I was smart enough to buy Canadian Tire at $0.50, and too stupid to sell it at $2.00.”

What’s your story about your best stock picks? Do you have any stories to share about stocks sold too soon, or ones you were “too stupid” to sell? Share them in the comments below.