On television and any website or newspaper, there are thousands of people offering offering up what you need to buy! But what I found from losing a lot of money by listening to them was that they forget to tell us one piece: when to sell.
In this post, guest contributor Douglas Goldstein, CFP®, shares some great insight on how to decide when to sell. If you’re interested in investing, this post is for you, but I’d also recommend Douglas’ book, Rich As A King. I’m giving away another FREE copy this week for reviews of our #1 bestseller, Make Money, Live Wealthy. Now, here’s Douglas…
How to Decide Whether to Sell Your Investments
A brief guide to preventing your emotions from ruining your investments…
When you make an investment decision, do you follow your emotions or your intellect? While money is often an emotional topic, in order to make wise financial decisions make sure your decisions are based on logic, not emotion.
The disposition effect
When faced with two stocks to sell, have you ever sold the winner, reveling in the great profit you’ve just made, while holding onto the loser hoping that one day it will turn around?
If so, you were influenced by the “disposition effect,” which often causes people to sell the wrong stock when faced with a decision of liquidating one position or another. Professors Hersh Shefrin and Meir Statman first introduced this concept after their studies showed that investors tended to sell winning positions too early and hold onto weak positions far too long.
Indeed, selling weak positions makes sense (since you may get the tax benefits of selling at a loss). Additionally, keeping the strong stocks (with the potential for more growth) makes sense since stronger stocks often indicate stronger and better companies. Is it always true? Of course there are no guarantees, and past performance is no guarantee of future returns. However, it’s important to realize that all too often emotions dictate the decision-making process, which doesn’t make much sense.
The power of free
The disposition effect is not the only time emotions may override logic in financial decisions. There is also the tremendous power of the word “free.”
When you see a sign at your local store announcing, “1+1 – Buy one and get the other one free,” do you buy because you don’t want to lose that great free deal while it lasts?
The temptation to get something for nothing is very strong. But, as behavioral psychology Professor Dan Ariely wrote in Predictably Irrational, “We often pay too much when we pay nothing.”
People often lose when they take up these great-sounding “free” offers. When a brokerage firms advertises, “200 free trades,” “free investment seminars,” or “no annual IRA account fee,” what does this mean? Does the client really need to trade 200 times? The seminars are usually held to sell something else, and while there may not be a fee on the IRA account, the firm will undoubtedly make its money by adding fees for advisory services, banking products, and more.
When making financial decisions, it’s vital to follow logic and rationality rather than your emotions. If you have a choice of buying or selling, look at the entire picture in real terms before making a decision. Apart from your actual losses or gains, consider tax implications, analysts’ predictions, and your financial plan.
When presented with a free offer, ask yourself what lies behind it. There’s no such thing as a “free lunch,” so consider what the company gains by your taking advantage of the offer. Read the small print, and remember that if something sounds too good to be true – it probably is!
If you can control your emotions and follow your intellect when making investment decisions, you will overcome one of the most serious barriers to financial success.
Douglas Goldstein is both a CFP® and an avid chess player. He and Grandmaster & World Chess Champion Susan Polgar are the best-selling co-authors of Rich As A King: How the Wisdom of Chess Can Make You a Grandmaster of Investing. Available for sale in bookstores, online, and at www.richasaking.com. Securities offered through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, SIFMA, FSI. Follow him on Twitter.