One of the key components to building an investment portfolio is choosing stocks that you feel comfortable holding for a long time
When investors ask us about some of the finer points of our conservative Successful Investor portfolio strategy, they often wonder when they should dump a weak stock from their portfolio and replace it with something new.
While building an investment portfolio, it is important to resist the ever-present urge to buy and sell. That’s because a sound portfolio, built through careful research, needs surprisingly few changes over the years. Trading less frequently is a good thing, because it gives you fewer occasions to make costly mistakes.
Building an investment portfolio should not involve market timing
You may decide to vary how much money you invest every year, depending on your view of the market outlook. But nobody can consistently guess right about the market outlook. Trying to do so is likely to cost you money about half the time.
If you invest more money in years when you’re confident about the economy or market, you may wind up buying more shares when prices are high. If you cut back on your investing in years when the outlook is uncertain, you’ll buy fewer shares when stock prices are low.
Investors may go so far as to try to improve their returns by taking money out of the stock market when they feel risk is high. They often get this urge after a few weeks or months of bad financial news or unsettling political developments. By then, however, the market may have already dropped enough to offset any negative developments.
Often, these temporary sellers wind up buying their way back into the market when the news has improved and stock prices have gone above the price where they sold.
Some brokers encourage this costly practice. From time to time, they may advise clients to “take some money off the table,” setting up a false analogy between investing and gambling. That’s in a broker’s interest.
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Every sale generates a brokerage commission. It also gives the broker the opportunity to sell the client something new, and make another commission. The client may re-invest in a product that’s more profitable for the broker—using the proceeds of a stock sale to buy an annuity or a universal life insurance policy, say.
However, investors using discount brokers also manage to sell low and buy back high, without any broker’s encouragement.
In the course of your investing career, you’ll make some good guesses about market direction, and some bad ones. You may make about the same number of each. But losses due to bad guesses have a way of overwhelming any profits you get from good guesses.
Bad guesses can spur you to sell your best stock picks way too early. You may lean toward selling your best stocks because you want to lock in a profit, and your best stocks generate above-average profit. However, your best stocks may have much more potential than average to keep on rising. Sell them too early and you’ll miss out on those above-average profits.
Bad guesses can also spur you to sell your best stocks (or your entire portfolio) after a long drop in stock prices, when the downturn may be close to its end. Thanks to these two drawbacks, bad guesses can devastate your investment returns over the course of an investing career.
Building an investment portfolio: keep long-term conservative investing goals in view
Using our Successful Investor approach, your goal as an investor building an investment portfolio, particularly if you follow a conservative investing strategy like the one we recommend, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meager profits or losses.
Unsuccessful investors can still make some profits. They just don’t make enough to offset the inevitable losses and leave themselves with an attractive return. If you focus on the idea that you never go broke taking a profit, you may be tempted to sell your best investments whenever it seems the investment outlook is clouding over.
On occasion, you may succeed in selling just prior to a major downturn, and buying back at much lower prices. More often, prices will soon hit bottom and move up to new highs. If you buy back, you’ll pay higher prices. If you had followed this strategy with Canadian bank stocks, for example, you could have missed out on some big gains over the years.
In hindsight, market downturns may seem to have been easy to spot. Spotting them ahead of time is much harder, and impossible to do consistently. After all, if you could consistently spot market downturns ahead of time, you could acquire a large proportion of all the money in the world, and nobody ever does that.
The problem is that you’ll foresee a lot of market downturns that never occur. All too often, the market-downturn clouds disperse soon after skittish investors have sold. Good reasons to sell do crop up from time to time, of course, even if you follow a long-term Successful Investor conservative investing approach. But “You’ll never go broke taking a profit” is not one of them.
How much do you focus on predicting market downturns or stock slumps? Or do you trust that you have a successful portfolio and feel better off ignoring fluctuations?
