The week before Halloween, my colleague Rachel Gearhart asked a group of Oxford Club investment analysts to write a few words about our most irrational fear and how we overcame it.
It’s a good question and – while I’ll get to my answer in a moment – it deserves a clarifying comment.
Many investment fears are entirely rational. After all, the capital you put at risk in the financial markets is real money.
Money that you earned, paid taxes on and saved rather than spent.
The knowledge that it could suddenly become a substantially smaller sum or – in a worst-case scenario – vanish entirely is not an idle consideration.
Yet, as experienced equity investors know, volatility is simply the price of admission.
(Although it has been so rare in recent months that I wonder whether the next “refresher” won’t come as a jolt to many.)
The reason Treasury bills and certificates of deposit offer virtually no risk of loss is because your return will be minimal and – after inflation – close to zero.
This is not satisfactory for people looking to build wealth or reach financial independence. And so we migrate to the stock market for higher returns – and the inevitable fluctuations that come with them.
How you respond to those fluctuations is important.
As I told Rachel, when I first entered the money management business 32 years ago, I was often afraid my winning stocks would suddenly turn into losers. That irrational fear led me to sell too soon.
“After all,” I told my young self at the time, “you never get hurt taking a profit.”
This is true only if you have the fortitude to never look at the stocks you sold again. Because a stock you’ve cashed in that goes up and up and up is a painful sight.
If you sell too late, you can lose 100% of your investment. But if you sell too soon, you can lose many hundreds of percentage points – indeed thousands of percentage points – of upside.
Readers who owned Apple (Nasdaq: AAPL), Amazon (Nasdaq: AMZN) or Netflix (Nasdaq: NFLX) a decade ago know exactly what I mean.
It’s bad enough that many investors don’t remain calm in a down market. But others can’t remain calm in an up market either. They get so excited about their gains that they feel compelled to lock them in straight away.
Then they regret it. If this has happened to you, you’re in good company.
Legendary fund manager Peter Lynch said in a recent Forbes article, “My biggest mistake was that I always sold stocks way too early… I was dumb. With great companies the passage of time is a major positive.”
And in his investment classic One Up On Wall Street he wrote, “Selling your winners and holding your losers is like cutting the flowers and watering the weeds.”
Of course, not all great companies remain great.
There was a time when Montgomery Ward, Circuit City, RadioShack, WorldCom, Blockbuster, Lehman Brothers, Enron, Borders and Bear Stearns were all up-and-coming growth stocks.
How do you hang on to the winners longer and get rid of the losers sooner?
Regular readers already know. It’s our trailing stop strategy. This keeps you in stocks while they are in a pronounced uptrend. And it gets you out of them once the trend breaks down.
It’s not a perfect solution. (No real-world strategy is.) But it works.
Good investing,
Alex
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Source: Investment U