Are we in a stock market bubble? We can usually know vaguely when another market crash is coming, as there are markers or trends to look at. Market crashes aren’t usually catastrophic, and they rarely cause you to lose all your money. 2020 has been a different year; while at home during the Covid-19 pandemic lockdowns, people became retail investors. Unsure about their financial futures, many people started pouring their money into the stock market. We are a few months into 2021, and currently it looks like stock market gains have peaked. Does this mean the stock market will crash? Is it time to get out of the stock market?
I grew up on country music. Maybe it was the wild west cowboy fantasies in Belize, or maybe it was the rural atmosphere, but every bus and restaurant in the Cayo district was playing classic country music when I was a child. I think of Kenny Rogers’ song “The Gambler” in these uncertain stock market days. We must be wise, we have to be paying attention, and we certainly have got to know when to hold ‘em and when to fold ‘em.
You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run
You never count your money
When you’re sittin’ at the table
There’ll be time enough for countin’
When the dealin’s done
Investors looking at “Buy and Hold” are traditionally looking to see how long it will take for an asset to double in value, often using the Rule of 72. You’re holding an asset for cash flow while building equity through appreciation. But if you are holding onto an investment that just isn’t making the return it once was, you may want to take a hard look at why that’s occurring. While you may only need to make some minor adjustments, don’t be afraid to sell something that is no longer working for you. Just like the cards in a poker game, each investment needs to be analyzed, options (cards) moved around and offers (wagers) made based upon other hands and what’s still left in the deck.
In poker, what cards to play and when takes thought, calculation, and a little risk. With investing, the same rules apply. Take a look at the investments you currently hold. Are they still making you money, or can you adjust without having them fall apart? Have the companies reached their peak value, or are they overvalued? It might be wise to sell overvalued stocks.
Investing takes organization, planning, analysis, and negotiation–a lot of the same traits that are valuable in playing poker. You will always want to research investments so that you are not playing your cards without looking at your hand. Don’t play your aces too soon, but go all in when you need to. Be prepared to know when to hold’em’, when to fold ’em, when to walk away, and when to run!
When to Hold ‘em, When to Fold ‘em
On average, every five years the stock market will crash. Each cycle usually lasts about twenty-two months, during which time readjustments and crashes are inevitable. Be prepared. Don’t sell when the prices are going down unless the company is going bankrupt. A 10% correction happens every eleven months on average, while a bear market will be signaled by a 20% loss, and a market collapse is considered a 40% loss. A full collapse has only happened three times in history.
Keep a “market opportunity fund” which is an amount of cash sidelined to invest when a market crash happens, when stocks are “on sale”, take advantage. Back in March 2020, I used cash on hand to buy my favorite stocks when they hit their lows, and as a result, throughout 2020 and into 2021, I saw a 40% increase in my account. I sold the technology companies I’m familiar with that were overpriced by February 17th 2021 for a nice, big profit. Now I’m holding cash, ready for opportunities. I’ve already found a few, but I think the market will go on sale again soon, so I’m holding cash for when it dips more and then slowly buying little by little to take advantage of dollar-cost averaging (DCA).
Good Reasons to Walk Away
There can be good reasons to walk away from an investment, but hoping to time a price peak isn’t one of them. You can end up wasting a lot of time and money watching for the ups and downs and buying and selling too often.
The real reason to sell and switch investments is to move into something better. The question to ask before selling an asset is, what am I going to replace this with?
It can be worthwhile to sell a mutual fund, especially one intended to be a core, long-term holding, if there is a management fee or other expenses that are higher than those of similar funds with the same investment objective. Replacing that fund with a lower cost, more diversified, and more tax-efficient mutual fund or ETF can make a lot of sense.
Chasing short-term performance — another way to say selling recent losers and buying recent winners — is always a bad idea. You can’t read the market, you can’t beat the market, so don’t try. Use good sense and research stocks to time when to sell and when to buy.
Don’t Let Emotions Drive You to Sell
It’s important to note that a significant problem with the decision to sell — especially when it’s individual securities — has nothing to do with costs, but instead has a lot to do with emotions.
Loss aversion, a well-known psychological behavior, is a way to say that we feel the pain of losing more strongly than we feel the pleasure of winning. Psychologists Daniel Kahneman and Amos Tversky first introduced this concept more than 30 years ago in their study, which built the foundation for what has become the field of behavioral finance.
This plays a big role in investor behavior; investors have a (bad) habit of selling winners and not letting losers go because of loss aversion, rather than for logical financial reasons. Realizing a gain feels good; we think we did something right and were rewarded for it. Realizing a loss can feel like we made a mistake and had to pay for it. It’s easy to want to avoid taking the loss and hope that a losing stock will ‘come back’… if only you hold on long enough.
But there’s a big problem with selling winners: taxes. A strategy of locking in gains and keeping losers is certain to be tax-inefficient, and it can easily produce worse after-tax returns. Reducing tax liability is always important, and even more so since 2013, when rates on capital gains went up and a new tax on investment returns was imposed on some high earners.
Another reason not to be eager to sell winners is that the trend can be your friend. Strong performers can keep rising, and it works in the other direction, too; assets that have lost value may continue to do so.
Hanging onto winners allows gains to accumulate and defers taxes on those gains, while selling investments that aren’t living up to expectations can prevent losses from mounting. Once they do mount, another quirk of human nature comes into play. Investor Brenard Baruch discussed the tendency for stubbornness to give way to panic, leading investors to dump their holdings at the bottom.
I’ve read a lot of investment books, and there is a trend that they share by constantly stating, “Don’t be afraid to lose.” You’re going to lose sometimes. If you want to make money investing, then get comfortable losing. You will find that you win more than you lose if you use good sense and research. Research is not listening to someone else’s opinions, it is carefully looking at the company as if you’re buying the company, because, in essence, you are. Investigate their earnings, the market cap, historical data and news. Read Investing for Beginners for more.
“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.”
Warren Buffett
Automate and invest like a robot; dollar-cost average by investing a set amount monthly.
Diversify in multiple places that you’ve spent time learning about and understand thoroughly.
Learn to determine panic selling and panic buying when it is happening; don’t try to time the market, but do wait and watch.
Inflation fears and bond yields, as well as interest rates hovering near zero has caused people to feel more comfortable with putting their money into the market. When people think the interest rates will go up, they will put their money into bonds which makes the yield increase, and the stock market dip. Recovery stocks are making a comeback in popularity, leading people to sell out of growth stocks, but then growth stocks will come back into vogue again. Do you see a trend? Investor Benjamin Graham would say that Mr. Market is bipolar. Don’t trust the market to direct your investing; that’s what everyone else is doing. Be different, be calculated. Research.
A recent February decision that interest rates are not going up leads investments out of bonds and back into the stock market.
What To Do Now
Keep 30% of your cash ready to buy stocks that are on “fire sale,” that is, growth stocks that are low. Good growth stocks are great to buy. Don’t sell because the stock has increased. On the other hand, don’t sell because it’s flatlined and not moving, and certainly not because the stock isn’t exciting.
Don’t sell because the price is going down either. If it’s a good company then buy more, rather than sell what you have. That’s what Warren Buffett does. Sell because outside factors are making people (Mr. Market) crazy. When the market is irrational and way overpriced, then sell. If you would not pay the current price for a share, or if you think anyone buying at the price the stock is listing is crazy, then sell it because it’s overvalued.
Sell because the company doesn’t have a future to grow. If they are either at their market cap and don’t have any more room to increase, or if the company doesn’t want to embrace the changes inevitable with the arrival of future trends, insights and technologies, then sell.
Judge the Business, Not the Stock Price
Overall, remember everything is going to be okay. These things are cyclical, as everything in life is. When we slow down and think about the ten year plan we have calculated, we will remember the day to day isn’t an indicator of our success. We don’t grow huge bounds in a day, or a week, or a month even. It takes years of steady, small growth to develop yourself, and it takes years to develop wealth.
Don’t be hard on yourself. Get comfortable with losing, and don’t do anything with money unless you have a whole research plan in place. Don’t buy because you feel you will miss out; buy because it’s part of your plan. Don’t sell out of fear. Don’t sell because you’re bored, sell because the profit is high and the company isn’t worth that high list price. It’s a journey, and you’ll learn and grow along the way. Most importantly, remember to have fun!
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