Time and time again, investors take profits by selling their appreciated investments, but they hold onto stocks that have declined in the hope of a rebound. If an investor doesn’t know when it’s time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice. The following information might help:
- Riding a Winner – Peter Lynch was famous for talking about “tenbaggers“, or investments that increased tenfold in value. The theory is that much of his overall success was due to a small number of stocks in his portfolio that returned big. If you have a personal policy to sell after a stock has increased by a certain multiple – say three, for instance – you may never fully ride out a winner. No one in the history of investing with a “sell-after-I-have-tripled-my-money” mentality has ever had a tenbagger. Don’t underestimate a stock that is performing well by sticking to some rigid personal rule – if you don’t have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting. (For more insight, see Pick Stocks Like Peter Lynch.)
- Selling a Loser – There is no guarantee that a stock will bounce back after a protracted decline. While it’s important not to underestimate good stocks, it’s equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it’s also an acknowledgment of your mistake. But it’s important to be honest when you realize that a stock is not performing as well as you expected it to. Don’t be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses. (For related reading, check out To Sell Or Not To Sell.)