Why are so many investors selling too soon?
The writer is co-founder and co-chairman of Oaktree Capital Management
In 33 years of writing memos to investors, I have never devoted one to the issue of selling. But I’m doing it now because it’s critical that we understand why many investors don’t focus on the long term and sell instead.
As I wrote in a note in 2015, I think most investors trade too much and to their own detriment and the best solution to market illiquidity is to build long-term portfolios that don’t depend on liquidity and trading for their success.
I believe there are two main reasons people sell investments: because they are up and because they are down. To understand this, you need to understand human behavior, because many investor actions are driven by psychology.
A lot of selling happens because people like the fact that their assets are showing gains and fear that those increases will disappear. Thus, they engage in “profit taking”.
Most people spend a lot of time and effort trying to avoid unpleasant feelings like regret and embarrassment. And what could cause an investor more self-recrimination than seeing a big gain evaporate? Instead, if you sell an appreciated asset, it puts the gain “on the book” and it can never be reversed. But that’s not a good enough reason to sell. The current fundamentals, their potential and the correctness of the asset’s price must be taken into account.
While I’m not saying that investors should never sell popular assets and make a profit, it certainly doesn’t make sense to sell things just because they’re up. Further, I believe it is generally a mistake to view realized gains as less transitory than unrealized gains. Proceeds from sales are usually reinvested, which means profits – and principal – are put back at risk.
As bad as it is to sell appreciated assets just to reap gains, it’s even worse to sell things just because they’re down. While the old saw says we should “buy low, sell high”, it is clear that many people become more motivated to sell assets the more they decline. They fear letting losses pile up, but selling things just because they’re down is a mistake that can provide great opportunities for other investors.
Additionally, investors often engage in selling because they believe a decline is imminent and they have the ability to avoid it. However, very few people have the skills to take advantage of market timing. Moreover, buying or holding – even at high prices – and suffering a decline is in itself far from fatal. Usually, every high in the market is followed by a high, and after all, only long-term performance matters.
Sidney Cottle, the editor of later versions by Benjamin Graham and David Dodd Security Analysis, introduced me to one of my favorite descriptions of investing: “the discipline of relative selection.” Every sale raises a series of questions, often relating to relative values and opportunity costs. What will you do with the product? Do you have something in mind that you think could produce a higher return? What could you be missing by switching to the new investment? And what are you going to give up if you decide not to switch and continue to hold the asset in your portfolio?
Or maybe you decide to sell and don’t plan to reinvest the proceeds. If so, what is the probability that holding the cash product will make you better off than holding the thing you sold? Selling a property is a decision that should absolutely not be considered in isolation.
If you shouldn’t sell things because they’re up and you shouldn’t sell because they’re down, is it ever right to sell? There are certainly good reasons to sell, but they have nothing to do with the fear of making mistakes, feeling regrets and looking bad. On the contrary, smart selling opportunities must be based on the prospects of the investment and they must be identified through rigorous, rigorous and disciplined financial analysis.
Most economies, businesses and markets benefit from positive underlying trends. If investors exercise poor judgment and reduce their market exposure through ill-conceived sells, they will not fully participate in these trends. This is a cardinal sin in investing. It’s even more true to sell things out of desperation after their prices have fallen, turning negative swings into permanent losses and undoing the miracle of long-term compounding of returns. What is clear to me is that unlike selling for psychic reasons, simply being invested is by far “the most important thing”.