A long-term reader of this blog suggested that I write about selling rather than buying investments. In everything I do I want to measure how close I get to my goals. Out of this measurement need, I require a time period. While it is of future betting interest to have the fastest moving horse or other investment at the end of a race, the payoff is the best performer for the fixed length of the race. The genesis of the TIMESPAN L Portfolios® was to focus on achieving the ability to meet disbursement goals on a timely basis.
This requirement is in some conflict with my instinctive ways to invest. Warren Buffett's favorite investment time period to invest is "forever." Mine may be even longer! (Over time some of my long-term investments have tripled to quintupled or more, beyond my exaggerated dreams.) Nevertheless, in focusing on most investors' needs to occasionally sell, I am commenting on five such events. But once again to judge whether selling is propitious or not, some measure of time is needed. Yes, to some extent the seller can celebrate the freeing of cash from investments in other assets. However, in the aftermath of a sale one is often asked whether the timing of the transaction was good. Thus to some extent a successful sale is measured as to how well the exit price compares with future prices. In this light the success of a sale is speculative in terms of comparisons.
The purpose of producing this post is to focus on the various thought processes that lead to successfully evolving solutions for five events when selling occurs.
1. The Avoid Switch
Rarely people, their companies, their politics, and their investments behave exactly as we conceived when we entered the transaction. It is difficult to find an investment that does not in some way disappoint, either by its own actions or factors beyond its control. There are times when the results are so good in the eyes of the market that the current price is way ahead of a reasonable long-term projection. Thus, at current prices there is considerable price risk. At times the risk appears to be too large and while an investor has not lost faith in the company, the investor may believe that the current price won't be repeated for an extended length of time. Most of the time the simple solution is to dispose of the holding. At times instead of selling out completely, reducing the size of the position makes more sense if there is not a screaming bargain available.
There are other occasions that selling may make sense. Several times I have been a holder of a security that I thought that I reasonably understood when either the company or the market did something that I did not understand. For example years ago a major conglomerate that I followed as an analyst switched from an under-reporting of earnings to including dealing earnings within operating earnings. Thus from my analyst's perspective, the company went from having a hidden kitty available to cover operating earnings shortfalls in some of its cyclical businesses to reporting every possible element of earnings. In other cases some companies made what I considered to be vanity acquisitions or questionable product pricing policies. In these cases I felt I did not properly understand these investments and exited them from my long-term holdings.
In most cases if an investor is not comfortable in his or her understanding of an investment they would be wise to avoid owning it.
2. The Bargain Switch
Sir John Templeton, my former data and consulting client, often phrased his sales in terms of purchasing better bargains. While occasionally what is better is only a lower valuation. To me these can prove to be "value traps." Normally things are cheaper because they should be - in terms of quality of product or management. However, we may have entered a period when bargain hunting can be productive.
The rise of exchange traded funds and other passive devices based on industry sector codes (technology) or market capitalization (Large Cap growth) has led to an unusual level of correlation of stock prices within these data sets. With expected changes in currencies, taxes, import/export mixes, etc., I suspect that there will be greater dispersion in stock prices within many data sets. If I am correct, the number of active mutual funds outperforming the various indices should rise which will attract some of the trading money out of passive/ETF vehicles into either selected individual securities or smartly active mutual funds. As the differences in valuations becomes greater I would expect that there will be opportunities to be long or short individual securities that could favor more bargain switching.
3. To Trim or Not?
As much as we would like to, we don't control the markets or the spending needs for our money. Thus over time we will have our investment wealth at a different balance than our beginning level. In many ways it is much easier to deal with a smaller amount of money than the beginning portfolio. In that case one should definitely trim the cash. The odds are that the decline in general market prices of stocks will eventually be reversed.
Many of those who have seen their income and wealth rise have already found that their gains do not lessen their problems but rather change them as well as their outlook. Once one has a portfolio, even if is limited to the number of holdings, it is an important part as to how one views the future. For most individual and institutional investors who have not consciously or subconsciously adapted the timespan philosophy, they will be dealing with a single portfolio that is probably focused on too short a time frame; e.g., one quarter, one year, or a single market cycle. Under these conditions the fear of near term losses becomes paramount. Thus, in a perceived expensive market the natural tendency is to reduce risk exposure. Perhaps the first technique should be to reduce or eliminate small positions on the basis that if they are still small they are not likely to be favored in the short-term.
Those who take a longer than current period view have history on their side for US equities and quite possibly for equities in general. The other historical trend worth recognizing is that great wealth comes from extreme concentration of effort, intelligence, and investment which suggests that concentrated portfolios in knowledgeable investors’ or managers’ accounts can produce great results.
After due consideration, trimming or completely eliminating positions could be the correct decision even if investments under other managers are doing well. It might be helpful to not let the tax man become the portfolio manager.
The shorter term oriented accounts will tend to be much more market price sensitive than the longer term accounts who are more focused on building absolute capital. I suspect the shorter term accounts have higher portfolio turnover and on average pay more in taxes over time than the longer term accounts.
4. The Familiarization Trade
Most of those who read this blog have a substantial portion of their wealth in tradeable securities. Some do not and receive the major portion of their wealth in a concrete package of stock options, private company interests, convertible securities, and various types of trusts. For many, these instruments are difficult to understand even with professional help that may not be specifically knowledgeable on these particulars. As these managers are unfamiliar to the new recipient, there is some substantial fear of making a mistake in the process of converting their new illiquid wealth to easily tradeable securities and/or cash. My suggestion (regardless as to the perceived value of the new investment) is to take the smallest portion of the investment and convert through the many steps to cash. This will equip the new owner with an understanding of how the process of unwinding the concentrated wealth package can be converted, which should help with some understanding of the benefits of not doing anything more than evaluating the next and future steps. As is often the case, selling something can be a valuable learning experience.
Recently those who have robust national or global political views in light of the strong to very strong stock markets are pondering whether they should quit the game and sell all their exposed equity positions. In terms of recorded history there have been a very limited number of times this has been a correct decision. Those instances have been very rare. But no one can be certain that at any given point stock price declines of more than half are not possible.
My own views are based on the beliefs that we have entered a different market phase. For at least the last ten years and perhaps longer we have been a world of single digits in terms of almost all main statistics of market prices, earnings, revenues, demographics, etc. I believe that starting with last summer we are accelerating into a double digit world, both up and down. In this new world sound investment principles will continue to work, but for some time the numerical bands won't. May this lead to an eventual market, if not economic collapse? Yes, it might, but not necessarily so. Rather than focusing on only the historic ratios, like Liz Ann Sonders of Charles Schwab, I am focusing on sentiment and currently the general lack of wild enthusiasm which is positive in my judgment that there is more time in this expansion.
As a contrarian and as a manager of portfolios owning mutual funds, I am often premature in my market judgments and actions. I am not yet ready to hit the quit button and retreat to cash, which is losing value regularly. Perhaps this time I will accept the downside volatility as the sign to exit.
Even if we do have a top and a subsequent fall, I hope I will not forget my responsibilities to future generations and totally "go to ground" in a foxhole.
There are times and conditions when selling is wise. However, these decisions should be made carefully without too much attention to the current and a reasonable review of the longer term future. The sellers historically have the burden of history against them, but they can win.
Question for all time:
Have you successfully sold an important part of your wealth and re-entered the market? Was it at a lower or higher price?
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A. Michael Lipper, C.F.A.,
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Contact author for limited redistribution permission.