Why is it so tough to say goodbye?
Whether parting ways with a loved one, a friend or family member, we all dread saying goodbye. We easily become attached to other people, situations or material objects that we adore.
The same struggle pertains to us when selling our top performing stocks. We become emotionally attached to stocks that grant us solid, consistent returns over time. No one wants so sell a company that has been delivering great returns. But the fact of the matter is, if you want to become a market-beating value investor, you need to set your emotions aside and only focus on your strategy and the numbers shown on your calculator.
Unloved value stocks will turn into loved ones over time. When that transition happens, you should consider selling your shares. Similar to a mother bird that kicks her hatchlings from the nest, you need to allow your stocks to fly the coop and avert from becoming greedy.
A recurring problem investors face is that we get too emotionally attached to our investments and swap rationality with greed when things are going well. Greed is the downfall of most investors.
How can you avoid becoming greedy? By finding the good in goodbye.
To be able to find the good in goodbye you need to consider the following:
There is no place for emotions in investing. Always think rationally. When doing finances, you should only trust your calculator, or the STRIDE scores and ratings, of course. Watch this video for more information on the STRIDE scores and ratings.
2. Consider what Warren Buffett would do
Take some advice from the 3rd richest man in the world. He built his wealth using a simple investing strategy and by taking a contrarian approach. Whenever you feel in doubt, just ask yourself: “What would Warren Buffett do?”
In this scenario I can tell you what he would do based on one of his most renowned quotes:
“Be fearful when others are greedy and greedy when others are fearful.”
3. Determine an exit strategy before buying anything
Evaluating a company by means of fundamental analysis gives you a good idea of the intrinsic value of its shares. Knowing the intrinsic value allows you to determine an entry point with an added margin of safety. While determining your entry point, you should do the same for your target exit point. Be rational and determine a realistic exit point by taking future growth into consideration. Do not make any guesses. Base your decision on calculations.
4. Abide by the principles of your investment strategy
Sticking to your principles will allow you to take emotions out of the equation. If your calculations were correct, your return on investment would be wonderful. Do not become greedy.
The following is an eye-opening example of the effect greed can have on your investing outcome:
You buy 100 shares of an undervalued company at a share price of $20 and hold onto those shares until the market turns. When you bought the shares, you decided that you would sell those shares when they hit your target exit point of $30, which is a 50% growth in share price.
After a while the market realises it made a huge mistake, and your unloved company’s share price starts increasing at a tremendous rate. It passes $22, $26 and eventually hits your target of $30.
At this stage, you are over the moon. Your investment has performed as expected and you couldn’t be happier about it. The rational investor would thank his lucky stars and sell the shares immediately at a magnificent profit. But unfortunately in most cases emotions get the better of us.
The emotional investor will think their stocks have performed extremely well and might grow even further. Why settle for 50% return on investment if you can get 100% or more? The decision to disregard your predetermined exit point is a cardinal mistake. You become greedy and decide to hold your shares.
Your shares continue to trade beyond your exit target, reaching a high of $34, and you pat yourself on the back for not selling at $30. The stock market is akin to the laws of gravity, what goes up must come down. The tides have turned, and the share price starts heading south. By now you convince yourself that the market will swing up again, but it doesn’t. Before you wipe your eyes, your shares are trading at your entry price and eventually even lower. At this point panic sets in and you sell your shares at a loss.
You sold your shares at $18 which means you lost $200, which isn’t too bad right? Wrong. You lost $200 plus the $1,000 of gains your shares achieved when it hit your initial exit point. Your total loss is $1,200. The only possible way to turn your loss into a win is to learn from your mistake and to never repeat it.
Cashing in and reinvesting your profits is ultimately the ‘good’ in goodbye. With reference to the above example, if you would have stuck with your initial exit strategy your return on investment would have been 50% and that is without taking the laws of compounding into consideration. If you were to reinvest those gains, your portfolio would enjoy healthy growth.
Cutting ties at the right time is greatly beneficial to your portfolio’s performance. The only way to be successful at value investing is to buy low and sell high. You want to avoid being greedy, resulting in buying low and selling even lower. Find the good in goodbye by selling your stocks at a predetermined and well-calculated exit point.
See how STRIDE calculates the best entry and exit points by using fundamental analysis, valuation and timing in our free eBook.