People make sell decisions for the wrong reasons. Based on their reaction to certain events, or on how the market is behaving. The one way to get past this behaviour is to ask yourself certain questions. This will force you to think logically and stop you from acting irrationally.
- What makes today different?
- Mental framework: Rewinding a bit and comparing your mindset today--when you're primed to sell--with where it was not too long ago can help you unpack and clarify your thinking.
Maybe you have more doubts about the fundamentals of what you own today than you did a week ago. For instance, you think your stock investments will see slower earnings growth or that interest rates will rise, dinging your bond holdings. Or it could be uncertainty and anxiety that prodding you.
What's important is trying to pinpoint why today is different than, say, a week ago, for it can yield insights into whether it's logic or emotion that's propelling your decision to sell.
But if you are a stock investor, you will have to make the call on each individual stock. Maybe some stocks are not overvalued, while others may be extremely overvalued. You cannot use the “market levels” argument to make a blanket call.
If you are a fund investor investing systematically, you may decide to discontinue further SIPs if you are uncomfortable. But this also depends on your investing time frame. If it is a decade down the road, please do not stop – consistency works to your benefit.
- Is that priced in?
- Mental framework: In order to profit you not only have to draw the right conclusion about the likelihood of future outcomes but also do it before the market coalesces around that view.
You could say you're selling not either because you expect market fundamentals to deteriorate or because you're feeling anxious and uncertain, but a little of both.
Maybe you're anxious because you think company fundamentals will erode or the economy will go into a funk. Or you believe because others are likely to share your same anxiety, it will augur a broader slowdown that dents company earnings, and so forth.
These sentiments are perfectly understandable, intuitive even. The question you want to ask yourself, though, is whether they are already "priced in" the market. After all, investors in aggregate tend to do a pretty good job of factoring in different possibilities and future scenarios, and that's reflected in market prices.
This is a tough one to answer as the market isn't going to come right out and tell you what is or isn't factored in. But it's a question you ought to tackle.
- Who is on the other side?
- Mental framework: Seeing things through the eyes of the other side can help you to assess some of the counterarguments to what you're considering doing.
Suppose you're able to build a case that the possibility markets will go sideways hasn't been properly priced in. The next question you'd want to ask yourself is what's the contrarian view? That is, who would be buying from me if I were to sell or reduce risk in my portfolio? You can't literally identify that party, but you can try to deduce the buyer's logic. Maybe the buyer thinks fundamentals will improve, investors will get even more bullish, or a little of both.
Attempting to answer the question will reveal the flaws in your thinking, if there are any. And will test the validation of your investment thesis. It will also point out if you are allowing certain factors to crowd out others that are important to bear in mind.
As Charlie Munger says: I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do.
- What will change my mind?
- Mental framework: If you're going to sell now, what would make you a buyer again in the future and how would you decide when the time was right?
Let’s say you sell, and decide to enter later. The market drops by 10%. You wait. It drops by another 10%. You wait because you are convinced it will fall further. It declines another 10% and now you are convinced bad days are coming, so you want the market to bottom out. And what if it suddenly begins to rally and you missed timing the bottom? You would have lost out investing at lows and not caught the rally either.
Market irrationality can last a very long time. Once you are out, it is difficult to psychologically get back. And till then, you will have to figure out where to park your savings.
Even if you are considering selling based on concerns over market fundamentals, try to envision what the fundamental picture would need to look like to kindle your interest in buying again. And as you do so, you'd want to ask yourself some of the questions above. Namely, by the time you conclude that fundamentals have improved enough, has the market already priced that improvement in? What might be motivating a seller to you at that time? And after you buy, what might prompt you to sell again in the future?
- Can I afford to take the risk?
- Mental framework: People use the work “risk” loosely. Understand what risk is to you before you make a decision.
How risky equity is to you will depend on which part of the life cycle you are in. If you have a really long runway to your goal (most probably a young investor), there really is no perceivable market risk. For the middle-aged, yes, you better be cautious. For a retired person, it is pretty risky.
There is often a disconnect between risk tolerance and risk capacity.
Risk tolerance is how much you can lose without feeling mental turmoil. Risk capacity is how much you can lose without changing your plans.
As you get closer to retirement, your risk capacity declines, even though your risk tolerance may still be that of a 25-year old. You will have to draw a balance between the two. The same applies if you are a 25-year old who prefers to err on the side on caution.
- Is this bringing you closer to your goals?
- Mental framework: Our entire aim of saving and investing is to attain our goals. If your behaviour jeopardizes that, think again.
Years ago in a media appearance, investment guru Bill Bernstein famously said: “If you've won the game stop playing.”
He went on to explain that before the Global Financial Crisis of 2008, many investors had “won the game”. They had pretty much saved sufficiently for a comfortable retirement. Yet, it was greed that egged them on to continue taking risks. Afterward, many of them sold either at or near the bottom and never bought back into it, irretrievably damaging their portfolios. themselves. So, “when you've won the game, why keep playing it?”
John Bogle once narrated this incident where at a party on Shelter Island, Kurt Vonnegut informs his pal Joseph Heller, that their a hedge fund manager host may have made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responds, “Yes, but I have something he can never have. The knowledge that I’ve got Enough.”
When you have made more from the investment than you anticipated, it takes courage to head for the exit. Because there is always the lure of more - “If I wait for a few more days, I can make more”.
A long-term mindset is not necessarily a fixed number of years. It is when you know what is enough.
The above has been written with insights from Jeffrey Ptak, the chief ratings officer for Morningstar.
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Larissa Fernand is Senior Editor at Morningstar India. You can follow her on Twitter.
