Chapter 35
You Can’t Go Wrong Taking a Profit—Really?
When talking about market adages that have stood the test of time, this one—you can’t go wrong taking a profit—has to be in the adage hall of fame. I’m not saying that it’s wrong, in and of itself, to take a profit. But this type of thinking has several unintended consequences I think you should be aware of and is one investment tenet to which I don’t fully subscribe. Let me explain.
1. Selling a stock only because it’s at a gain means having to replace it with another security (if that’s your objective), forgoing further possible gains in a position that’s already showing you a profit, and having the pressure of having to select another winner—all from scratch. With a stock that’s showing you a decent gain you may even have your selling price (or stop order) set above your original purchase price. That’s a nice feeling, but absent when you have to start over again with a new security.
2. All other things being equal, why would you want to put one of your winners on the chopping block first when it’s the losses that may well be the weaker link?
3. Taking a profit in a stock puts a final lid on how high it might go. Sure, you tell yourself, I’ll buy it back at a lower price, but in a primary uptrend, chances are that you’ll miss that opportunity. And I need not tell you the (psychological) reluctance investors feel to buy back shares at a price higher than that at which they were sold—wrong as that thinking can be.
4. Using a gain or loss as the sole criteria for making an investment decision is like choosing a single personal trait and making that the only determinant for finding the perfect mate. I’m not saying not to consider selling your winners if your analysis suggests you should, just that it’s not a one-dimensional decision. One avenue you might consider is selling a partial position in the shares and retaining the rest to give yourself a chance to extend your gains while using a risk management approach to protect those winnings. When I do so, it’s always based on my technical analysis of the shares in question.
Moral: The temptation to sell your gains instead of your losses can seem overwhelming at times. It’s a much better feeling to sell a stock at a gain, take some credit, and wear a smile than it is to sell at a loss and admit financial defeat. And remember, when you sell a position at a loss, the verdict is final. That’s not something that many people come to terms with easily. The easy road, however, whether investing in the stock market or in a personal relationship, is often the wrong road. Don’t be so quick to grab your gains based solely on the fact that they’re gains.
Chapter 36
Deal with It!
In chapter 33, “Dangerous Phrases,” I listed more than three dozen market sayings I’ve heard over the years that bother me to no end, some more than others. Some have been accepted as substantive statements simply because of the frequency with which they’ve been stated. Take number eight on that list, the utterance that a loss in a particular stock is “not a loss unless I take it.” It drives me nuts!
This line of thought indicates an inability to admit one’s investment errors. It reasons that the sale of that stock would make the loss final whereas continuing to hold it, even at a significant loss, still leaves the door open for some long-shot opportunity at a rebound. Failure to face up to an unhappy investment scenario certainly won’t make it go away, any more than not dealing with your emotional baggage will prevent continued difficulties in your personal relationships with friends and family.
There are times in one’s investment career, however unpleasant, where a loss is inevitable. You’ll need to accept this outcome. The only question is how large will it be? Simply thinking that time is on your side and that by waiting long enough the shares will return miraculously to their original purchase price soon (or possibly ever in your investment lifetime) isn’t market reality.
Look no further than the major market peaks in 2000 and 2007, from which some huge declines ensued. Some well-known companies back then aren’t even around today, or sell at mere fractions of their heyday highs. Losses that looked large became much larger, and stocks that looked cheap became much cheaper. There are many examples. When I hear someone opine that “it’s not a loss unless I take it”, what often follows is “besides, how much lower can it go?” (number one on our Dangerous Phrases” list). Regarding the latter question, the market will often show you. Furthermore, focusing a disproportionate amount of time and energy on situations like this can distract you from sufficiently monitoring the rest of your portfolio, just as turning a blind eye to a problematic marital, business, or parenting situation does not make for clearer viewing.
You need to tackle your investment decisions head-on. The rationalizations for delaying action abound, and none are acceptable when it’s your hard-earned capital on the line. The market has neither time nor tolerance for excuses. How often have we heard it said in life that “we are our own worst enemy”? It’s also true in the world of investing.
Moral: In the market, as in life, sometimes you need to resign yourself to the fact that a negative outcome can’t be avoided. The only question is how bad will it be? After all, markets and life both have their ups and downs. The challenge is how to keep the outcome manageable so that the situation doesn’t deteriorate further. The market is not a monetary arena where being right more often than you’re wrong translates into a profitable outcome. Far from it. A single loss can outweigh multiple profitable trades, so deal with the situation at hand.
Chapter 37
The Hard Way
How many times have we told our kids to learn from our miscues and errors in life so they don’t have to repeat them? We want to protect our kids from making the very same costly mistakes that we made in our youth. Needless to say, this is far easier said than done, since sometimes the advice we render to our kids goes in one ear and out the other. Some of this reluctance to learn from the miscues of others probably has to do with youthful overconfidence, and some with stubbornness or a “know it all” attitude (factors that are also negatives in the investment arena). True, if you make the mistake yourself, it will be more indelibly etched in your mind. But at what cost to learn? If it involves anything having to do with safety, that price is much too high. That’s why kids should be driving safe vehicles. That’s why we give baby sitters the relevant contact information when we go out. That’s why we have fire extinguishers and smoke detectors in our homes. Just in case.
I’ve already said that the business of investing is not one that you can learn by trial and error because by the time you become smart you can also be broke. It’s simply far too costly a lesson. What good is becoming learned, or at least better informed about investing, if the cost of that education is a loss of your hard-earned investment capital? That’s why you absolutely must be willing to learn from the mistakes of others, including seasoned professionals who endured some rough financial sledding at times in their careers.
Read some books written by or about successful money managers, as well as those who have erred badly despite years of investment experience. What were their key mistakes? Were they able to recover from them, and if so, how? What would they have done differently? What changes have they made in their investment strategy to avoid those very same costly financial errors in the future? No matter how much experience you have in this business, the market doesn’t know your résumé. Read accounts of the 1929 crash and ensuing bear market. Revisit the 1973–1974 bear market span. Read about the Long-Term Capital Management hedge fund failure in 1998. And others. If you can learn lessons from those investment blunders, for free, imagine the dollars and the worry that you’ll potentially save yourself!
Flexibility is a trademark of successful investing in the stock market, where hard work and losses are the only guarantees, and unexpected news can trigger sharp moves in both directions. Learning the hard way isn’t often the smart way, either in life or when investing in the stock market. Why have to endure that costly experience? I’d much rather
follow the phrase “take my word for it” from someone whom I respect and can learn from.
Moral: There are times in life where learning something the hard way is simply too costly a lesson. The most important examples are those where that cost could endanger your health or safety. Stubbornness isn’t an asset if it means ignoring the advice of respected folks who’ve already learned important lessons and can impart that valuable knowledge to you. Why risk repeating their mistakes all over again on your own? This applies to the business of investing as well. The decisions you make can affect your financial life and that of your family.
Chapter 38
Company Stock
Of the myriad of decisions that you make when deciding what to do with your paycheck, one is whether to invest in your company’s stock. I can only address this issue in a very general way because different companies have varying programs in this regard. And obviously, I don’t know your financial position.
What I do want to get across, however, is that simply because you work for a company you like and believe in doesn’t mean that you’ll make money in the underlying shares over the near or longer term. Bear markets have a way of seeing to that. Also, chances are that if you weren’t working for your company you wouldn’t be investing in its shares in the first place. Additionally, if you already depend on your salary, bonus, health, and other benefits from your employer to support your family, this already represents a significant involvement and would be something to consider in deciding if, and how much, you should invest in your company’s shares.
I’m not passing judgment on whether or not you should invest in your company stock. Look at how many folks have made beaucoup bucks doing so—enough to change their lifestyles for the better. But there’s also a downside, and a potentially large one at that. All I’m suggesting you do is weigh the aforementioned factors I mentioned, as well as others that you’ll want to consider, prior to committing your hard-earned dollars to your company’s stock. Life’s equivalent consideration would be to determine to what extent (if at all) you want to become additionally involved in a personal endeavor in which you’re already broadly involved.
Say you have a close friendship with someone who also happens to be your neighbor, is in the same business, and who you and your family socialize with regularly. He approaches you with an opportunity to invest in a summer home together. Is it worth becoming increasingly involved in such an arrangement? Maybe you sense additional opportunities to justify doing so; maybe not. There’s no one answer for all.
Moral: In deciding whether to participate, and to what extent, in your company’s stock purchase program, consider weighing the extent to which your life is already connected to that enterprise financially and emotionally. Examine your present and future monetary obligations. Weigh the benefits and risks in each category, listing the plusses and minuses to help reach a decision.
Chapter 39
It Was Grandpa’s
Years ago, when I was working at E. F. Hutton & Company, a broker called to ask my view on Digital Equipment. He told me the story about how a substantial number of its shares had been in his family for many years and was now in his financial hands. I could sense that he had a family attachment to those shares. Digital Equipment was an equity selling in the triple digits at the time, and I don’t think he was particularly thrilled to hear me say he should employ a risk management strategy with accompanying stops. As well as I can recall, I advised him to sell part of the position, as it comprised a pretty good chunk of his capital and the shares’ technical pattern had waned. His response, while appreciative, was a reiteration that the stock had been in his family for many years, which gave him pause in parting with the shares.
In situations like this, however personal and sentimental, the stock market doesn’t know your personal status. It never has, it never will, and it doesn’t care. I tried to convey to him that if the stock were technically vulnerable, why would his family want him to retain the shares if it meant the potential loss of significant capital? Would this be what his grandpa, who gave him the shares, would have wanted? Besides, we’re only speaking about stocks here. I suggested an alternative—that he retain a small piece of the position and keep it in his family—forever, if that’s what he wanted. I hoped that addressing this psychological side of the situation would allow for a more flexible approach with the larger, remaining part of the position. To this day I don’t know what he decided to do, but the stock eventually slid sharply and the underlying company was eventually acquired.
Like it or not, the emotional component of investing is a more important part of the process than most folks realize. And if it weren’t difficult enough to successfully invest in the stock market, making investment decisions based on a family history of holding a particular position or other such emotional external factors fails to address the investment itself. That’s often a recipe for trouble.
Moral: We all hold dear mementos and family treasures that have been in our families for years and are priceless to us. We wouldn’t part with them for the world. Stocks deserve no such consideration, however. Holding on to them means assuming monetary risk, possibly substantial. Sentimental value won’t help your holdings in a primary bear market. The above story is yet another example of an external factor that can poorly influence investment decisions. The two need to be separated—once and for all.
Chapter 40
It’s Not Going Broke
You won’t hear the phrase “the company’s not going broke” uttered by anyone holding a stock at a profit—only at a loss. It’s one of the poorest excuses I’ve ever heard for retaining shares in various stages of decline. Is this really a basis on which to hold a stock? Or an investment strategy? By thinking this way one doesn’t have to address the fact that they’re under water in their investment. I’d say they have a problem dealing with the situation and the four words in the title allow them an “out.”
Let’s assume that the underlying company isn’t going broke, as most do not. I’ll grant you that. So what? Does that mean you should keep their shares for that reason alone? Go online and check how the shares of many household names known to millions of people performed in bear markets. The declines were painful in spite of the popularity of the underlying companies—corporations that span a wide array of industries and whose products and services we greatly enjoy using. Even with some popular market indices trading near their respective multiyear highs as I write this, the underlying shares of numerous well-known, large companies are visibly under their multiyear peaks.
Trouble is, by using the terminology mentioned in the title you’re using a worst-case basis—not to protect yourself on the downside by trying to control the loss, but rather as a rationalization to potentially increase it! That’s the opposite of what risk management is all about. Just because the absolute worst case probably won’t materialize doesn’t mean that the situation can’t become noticeably worse than it is now.
You can apply this concept to a range of life equivalents. Just concoct a worst-case scenario that probably won’t occur, and use that as an excuse for not taking action or refusing to address the situation—like delaying a badly needed roof repair on your home because, after all, it’s not going to collapse. Or putting off a trip to your dentist for a necessary procedure because your teeth aren’t going to fall out.
Moral: Brief as it is, this chapter speaks once again to an investor’s thought process—particularly when he’s losing money. I mentioned the title in chapter 33, “Dangerous Phrases.” Rationalizations allow you to postpone difficult decisions in that regard. And by using only two outcomes—a worst-case scenario versus a current situation—lots of other gears in between are omitted. For instance, can’t a business that’s losing money lose increasingly larger sums over time, even if it doesn’t go bankrupt? Suffice it to say there are several stages between a paper cut and a hemorrhage.
Chapter 41
It’s a “Blue Chip”
I’m n
ot sure what the term blue chip means anymore. To me it’s a remnant of markets past—not the present or the future. Years ago when I fell in love with this business, a “blue chip” stock was a major-name corporation, often with a world-renowned product, an admired corporate giant carrying a high financial rating and often paying an increasing dividend. It would usually boast an impressive streak of financial results and be a suggested core holding in many portfolios for individuals and institutions alike. I can still remember this term being thrown around the brokerage houses I frequented, with those owning shares in names so labeled a point of portfolio pride. But that’s all it is—a label.
Keep in mind that when I started visiting brokerage houses on a regular basis in the early 1970s, investors hadn’t witnessed a big bear market to speak of in decades. We all know what happened in that (early 1970s) period, as shares in the bedrock of American business took a serious southerly ride. Belief that sound financial corporate statistics would somehow better insulate the underlying shares from severe damage and that dividends would somehow help cushion the bear market blow was proved shallow. What an education I received during that period! It caused me to question conventionality at a young age; I’ve never stopped since.
Take no comfort in the fact that you own a well-known name that the Wall Street analytical “experts” may be recommending strongly. I’m not knocking them. Many have brilliant academic and industry credentials and IQs in the “Mensa” category. There’s just one problem with that—the stock market doesn’t know anything about credentials. Its verdict is final, as rendered by the price of the security in question. Just like a major storm ready to wreak damage on anything in its way cares little about the boat captain’s impressive seafaring credentials, you either need to get out of the primary bear market’s way or experience its brute force head-on!
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