Know When to Fold ‘Em
Posted by Gail | Filed under Investing
While the markets were dipsy-doodling all over the place, no one wanted to know from nothin’. Now that some sanity has returned (maybe), it’s time to put things in perspective so that the next time the market starts to do a jig, y’all have a plan.
When the markets act in totally unexpected ways people panic. The investment world changes so quickly, it’s pretty hard to keep abreast of all the changes that can affect individual investments. But selling at an inopportune time is dumb. So is selling for the wrong reason. If you establish some rules that help you determine when to fold your investment tent, you’re much less likely to make a bad decision. Here are 10 of my favorites:
Rule #1: Don’t overreact. A good rule to start with is that you should never sell your stock in reaction to a fall in price. People do this when they’re not sure why they bought the stock in the first place. Along comes a change and they panic. If you’ve done your homework before buying the stock, you’ll know that stock movements are often random since they can be affected by all sorts of variables. Since short-term changes usually have no bearing on the true value of a company, at most it should be a signal to look at the company to see if anything else has changed.
Rule #2: Don’t get emotional about a stock. It’s okay to like a stock. It’s deadly to fall in love. One way to do this is to establish a realistic target for the stock’s growth. When you hit that target, as a value investor you would sell. As a momentum investor, you’d look at the stock to see if the moment signals are for further growth. A year-to-year comparison of net earnings will show the company’s growth overall. If you’re looking at quarterly results, make sure you’re comparing fourth-quarter results with fourth-quarter results. Since many companies are susceptible to cyclical changes — retailers typically post very high profits in the final quarter of the year because of the holiday season — a comparison of different quarters won’t paint an accurate picture.
Rule #3: Sell when the market is up. Sounds like an obvious statement, doesn’t it. Yet tonnes of people jump out when the market takes a downturn. Smart investors use these downturns in the market to find value, or to retrench their positions. Selling in a down market is a sure way to generate a loss, which is okay if you need the write-off, but not so okay if you’re just scared.
Rule #4: Dump wildly popular stocks. If your stock suddenly becomes the analyst’s darling, it’s probably time to unload it. The stock’s popularity has likely already been built into the price, so it’s questionable if that stock has a lot more up in it.
Rule #5: Management matters. If you have any reason to doubt the honesty or integrity of a company’s management, sell immediately. The management team is as important as all the number you look at in choosing a stock. While good management can turn around a company that’s been suffering, nothing can wreck a company faster than bad management. This rule also applies when the management of a company you’re already holding changes. Whether it is through an acquisition or merger, or through the seasonal comings-and-goings of management, if you’re not sure about the new management team, that could be a signal to sell.
Rule #6: Look at P/E ratios relative to growth. If the P/E is higher than the projected growth rate, it’s a signal that the stock price could decline. The question to ask yourself is this “Would I buy this stock today?” If you answer “no”, sell the stock.
Rule #7: Assess significant changes in the industry. A strong new competitor may be a good reason to sell a stock. So may new legislation, which changes the environment within which your company must do business.
Rule #8: Check to see if insiders are trading large blocks of the company. If they are buying, great. But if they are selling, you have to wonder what they know that you don’t.
Rule #9: Rebalance your portfolio. Weed out non-performers and take some of the profit you’ve accumulated in shares you’ve been holding for a while.
Rule #10: Don’t forget the taxman. There are times when it makes sense to take a loss or crystallize a gain for tax purposes.
These are the most basic rules. If there’s anything in this you don’t understand, it’s because you don’t have the knowledge (yet) to be an investor. Faking it only gets you to miserable. If you want to invest but need a guide, make sure you’re fully confident in the person you choose to help you invest your money. You worked hard for that money!
June 4, 2009 at 9:04 am
I work at an investment dealer, and I get exactly what you’re talking about! So many people panic, and no matter how much you tell them to stick with the plan, they will sell at the lowest point and lose all the gains they’ve made.
Anyone with any investment knowledge, knows the adage “buy low, sell high” but since money is so emotional, it is extremely hard to let logic guide you.
June 4, 2009 at 9:32 am
Rule #9 is the golden rule for me – “take some of the profit you’ve accumulated in shares you’ve been holding for a while”. Without taking the profits you have made you are only what I call a “paper millionnaire” – you havent’t made any money until you sell at a higher price than you bought at. So, periodically take your profits, no matter the stock price!! Reinvest that profit into something “safer” to protect your gain.
Before the tech bubble burst, I had about $1000 in a very high risk, venture capital stock (only a tiny portion of my entire portfolio) – it made me a ton of money, doubling every couple of months or so – BUT, I only made this money because I sold it regularly to get my profit out and left my initial $1000 investment to continue to grow. My initial $1000 is only worth about $300 right now, but so what, I’m still ahead of the game because I took at least $10,000 out of that in profits and reinvested them in longer term, deeemed “safer” investments (bond funds, GIC’s, etc.).
One final note, and this is something I can’t seem to get across to my friends — if you have a financial advisor – they are not in charge of your money – YOU ARE! Use their expertise for what it is, find someone you trust and establish a relationship with them. That means, meeting with them quarterly (or at LEAST twice a year) to review your portfolio, make adjustments, review your risk profile, review any upcoming changes in your life, etc. Don’t absolve yourself of all responsibility when you have a financial advisor – YOU are still the decision maker. If you have all your money invested with an advisor and you don’t monitor it regulary, you’re a fool (albeit with a heart of gold!).
June 4, 2009 at 12:42 pm
Thanks so much for these rules. I have been leary of investment mainly because of my lack of knowledge on what to do. THese are great rules to follow! And thanks Sedonahike for your input… something else to think about.
June 4, 2009 at 1:03 pm
Silly question…I started rrsp’s a few months ago. I have no idea where that money is going…$50’s a month that I could part with. I think she said something about diversifying.
June 4, 2009 at 1:05 pm
These tips are great!
Unfortunately I really don’t know enough to say if the bits in my investments are doing any of that stuff…. mostly because I have a “diversified” moderate risk fund, and I hate to admit it, but I haven’t a clue what is going in and out, and I have to keep faith that these “professionals” are making the right decisions on my investment’s behalf!
The one thing I do have control over is whether to bail out or not.
My darling husband had a panic attack when the first major drop happened, he wanted to sell it all and cash out, NOW. But I felt it was time to hold strong and wait. It dropped further (of course) but we are still putting money in (buying more shares per dollar). I hope I made the right choice, though the market value is still worth less than the total dollar value put in, we have 30 years still until we need to think about it as a source of income. The way I try to look at it, the money isn’t lost or gained until the funds are cashed in, right?!
It’s so hard to think that far ahead when you see it looking all crappy…. Buying and selling stocks myself is an intriguing concept, but a little too much like gambling since I am not educated enough to make wise choices.
June 4, 2009 at 1:22 pm
Erin, find out! One phone call or meeting should do it. Since you have just started out, I presume that you have opened up an RSP account with your bank (that’s usually where most people begin). That RSP account is likely a savings account with a low interest rate coming to you.
You have lots of choices of what to do with the money – the first step is making the contribution, congrats, you’re on your way. You can leave your contributions in a savings account however they will not grow very fast. Once you have accumulated enough capital – say $1000 you could then buy a Guaranteed Investment Certificate (GIC), which would yield a higher interest rate. You can also buy stocks or mutual funds (if you educate yourself about what you are getting into and understand the risk involved).
If your account is with a bank then you must be aware that they will only talk to you about their products (nothing wrong with bank products!), just be aware that the advice and options you get will not show the whole picture of what is out there for you.
Good luck. The hardest part is getting the monthly payment started, the second hardest part is figuring out what to do with it to make it grow.
June 4, 2009 at 5:22 pm
Erin, +1 on finding out.
If you get any grief, shutdown the operation. (Don’t ask to cash out cause that might be more trouble and cost you more in taxes than its worth) but stop contributing further.
Questions to ask:
1) What exactly am I investing in?
2) What is the ANNUAL Management Expense Ratio I’m being charged, if any (aka MER). Don’t buy the argument that ‘oh its free’. What other fees are there? Ain’t nothing free.
3) What are the risks involved?
But don’t take this response to mean stop investing cause its scary. It’s a bit like learning to drive, really. You have to start somewhere and its important. If you don’t start, you might not (most people I know who can’t drive in their 30s didn’t learn in their teens like the rest of us).
June 5, 2009 at 9:09 am
[...] Now that stocks have recovered somewhat, Gail says investors should establish some investment rules to keep emotions in check. [...]
June 5, 2009 at 9:49 am
Sedonahike, great information! I wish you had a blog – I’d love to read more from you.
June 7, 2009 at 12:21 am
I totally agree on what you say. Setting up an exit strategy for a stock is a critical step in trading. Your advice is appreciated.