Starting an online investment portfolio is easy. Just open an account with a broker and buy some shares. But, investors find that selling a stock is one of the hardest things to do, whether it’s selling to crystallise a profit or a loss.
This may sound illogical to many, but this phenomenon provides an interesting insight into investor psychology. Selling at a loss is like admitting you’ve made a mistake, and no one likes to be in that position. Collecting a profit can also be hard as investors wonder if they will miss out on further gains in the future.
For these reasons, selling indeed feels much harder than buying a stock, and this means investors are predisposed to holding on to a stock for all the wrong reasons. In our experience, there are five bad reasons investors use as an excuse not to exit a position. You need to be aware of them to avoid this dangerous pitfall.
1. Holding an inappropriate stock
It’s easy to get bombarded with ‘buy”’ or ‘sell’ recommendations from TV, newspapers or email. Before you get started with any trading, ask yourself if the investment meets your objectives and strategy.
Often, the legacy of a poor performer in the portfolio is not because you didn’t sell it, but instead, you should never have bought it in the first place.
2. Holding on for too long
Another common mistake many investors make is once they’ve acquired a stock, is that they fail to monitor the performance of the company to ensure it continues to meet original expectations.
‘Stock neglect’ is common in the world of trading, but it can be disastrous for your portfolio. You need to get into the practice of monitoring your stocks regularly – ideally once a week.
You should also ensure that when the fundamentals of a stock change for the worse, or if it no longer meets your investment objective, you need to act quickly to sell it. There may be a few dogs that recover but, in most cases, you will be glad you closed that position.
3. Tax reasons
Don’t get too bogged down in the nitty-gritty when it comes to generating a tax event. Many investors make the mistake of focusing too much on this and often question if they are sitting on a significant capital gain or whether they’ve held the stock for a full 12 months.
Not selling when you know you should, will end up costing you. Acting at the appropriate time, irrespective of the tax consequences is essential to building a successful portfolio.
Instead of focusing on taxes when trading online, you should look to employ a good accountant and/or financial planner who can set up the appropriate tax structure for you. This will give you greater peace of mind and be one less issue for you to worry about.
4. ‘It’ll come back’ mentality
Some investors go through what we term as ‘rear view investing’ which can bite you twice on the posterior.
Just because a stock may have previously traded at a higher price, the failure to exit at its previous peak can stop many investors from getting out altogether.
There are no guarantees that a stock will return to its former glory days and failing to let go of it when it’s underperforming due to a weak outlook and poor fundamentals will often cost you more in terms of a capital loss.
Novice SMSF Trustees often overlook the fundamental drivers of the price decline. Always remember that there is usually a justifiable reason as to why the stock has fallen 80%, and therefore while it had once traded higher, its current predicament means it’s unlikely to regain its losses anytime soon. What’s worse, an underperforming asset will tie up your cash, and this means you won’t have the opportunity to invest in a better business. This is known as the ‘opportunity cost.’
Online investment platforms often have alerts that you can set up to help you monitor price trends.
5. The shame of being wrong
Lastly, many investors decide to hold on to stock because of pride. They just find it hard to accept that they’ve made the wrong decision regarding a stock’s prospects or its appropriateness.
Investing is an emotional endeavour but investing on emotions can be detrimental to the health of your portfolio. To be a successful investor, you need to remove emotions from the process so that you can make rational and logical decisions in the best interests of your portfolio over the long-term.
There’s nothing wrong with making mistakes. The crime is not having the courage to correct it.
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Lincoln Indicators is a fund manager and creator of Stock Doctor, Australia’s premier DIY Investment Platform. Elio D‘Amato is the Executive Director at Lincoln Indicators. www.lincolnindicators.com.au
Important: Lincoln Indicators Pty Limited (Lincoln) ABN 23 006 715 573, as Corporate Authorised Representative of Lincoln Financial Group Pty Ltd ABN 70 609 751 966, AFSL 483167. This communication may contain general financial product advice. Our advice has been prepared without taking account of your personal circumstances. You should therefore consider its appropriateness, in light of your objectives, financial situation and needs, before acting on it. If our advice relates to the acquisition or possible acquisition of a particular financial product, you should obtain a copy of and consider the Product Disclosure Statement (PDS) at www.lincolnindicators.com.au before making any decision.