There’s a “sell first, ask questions later” mentality that’s roiled the market in the recent volatility. It’s actually been around for a long time, but it has been as awful as any time since the market was in the midst of a serious crash in 2008-2009.
When it’s all said and done, most investors will regret their actions, although few will even acknowledge them. I talk to a lot of people that act like selling their holdings in great companies was okay because of the turmoil, but they never admit — or maybe can’t see — how their actions actually helped create the turmoil.
In the 1960s, investors held stocks six years on average. These days, it’s less than six months. There is no way that the fundamentals of each stock in the market change so dramatically in such a short length of time. Much of this selling is based on emotion, and that’s where investors make mistakes.
That’s why it’s important to create an exit strategy — it will prevent you from jumping to conclusions and making rash decisions.
My general rule for selling is pretty straightforward: If the reasons you bought the stock in the first place begin to change, it’s time to move on to other opportunities.
But in times like these when the market volatility makes it look like a company is failing when, in fact, it’s just as strong as ever, it’s important to be able to keep your emotions in check.
That’s why I’ve come up with a list of four questions that I believe all investors should ask themselves before creating an exit strategy.
1) What is your true threshold for pain?
I don’t mean physical pain here — I mean emotional pain. As in how far are you comfortable letting a stock slide before taking your money off the table? If you become sick to your stomach once a stock pulls back 10% from your buy price, and possibly even more in volatile times, the stock market may be a tough place for you — and I’m sure you’re realizing that right about now.
It’s best to know your comfort zone. I recommend determining a reasonable threshold and trying to stay with it so you’re not anxious over your stocks every day that you own them.
2) Can you take a loss and come back swinging at the next opportunity?
Unfortunately, too many investors — especially those who don’t determine their pain threshold or don’t stay with it — end up taking a bigger loss than they ever intended on taking. What happens then? They boycott the market, which is the worst thing to do.
So when a stock is down to the point where you’re not comfortable, don’t freeze. Sell it and move on. You don’t want an emotional anchor to turn into a financial anchor.
3) Why are you in the stock market or a specific stock to begin with?
Taking a loss doesn’t mean you’re unintelligent, but not knowing why you’re accepting that loss or why you bought into that stock in the first place does mean that you’re not thinking. This is similar to what we talked about earlier, but there are different answers.
For example, if you’re a momentum investor, remember that once momentum starts to stall — or has stopped — it’s likely time to move on. If you buy a stock because of the company’s underlying fundamentals, be sure to keep that in mind when the stock falls along with the broad market.
It’s absolutely imperative to know your reasoning behind investing if you want to formulate an effective exit strategy. Otherwise, irrelevant factors will seem relevant and you’ll end up making mistakes. And those mistakes cost you money.
4) How much money do you have in the market to start with?
If you dump all of your money into one position, your only option is to let that holding sit until it reaches upside objectives. If it’s down, you’re losing money. If it’s up, you’re making money. But there’s no balance, and I’m big on balance. To put it simply, don’t put all of your eggs in one basket.
You want your exit strategy to work for you, not against you. And in order to make that happen, you have to be smart with your investing. Balance your portfolio. Don’t accept more risk than you’re willing to undertake. Understand why you’re backing the company you’re investing in. And make sure you know what you’re getting yourself into.
Listen, I get that it’s really hard to hold stocks that are losers on paper, but if you picked stocks that are winners in the real world, it helps. Ironically, the advent of financial media, particularly television, has made the situation worse. With an ambulance-chasing mentality and an understanding that bad news and fear draw more eyeballs to websites, the slightest miscues are magnified.
Investors looking for stocks to go straight up or never be challenged are really not investors at all. The fact is that when great stocks take a hit, it creates great opportunities to buy on the cheap. With massive outflows of mutual funds and hits to big names like Disney (DIS), many investors are going to sell first and ask questions later – or even worse, never ask questions at all.
Whether they do or don’t, here’s the answer: Great stocks only stay down for a short period of time, and investors taking hits because they can’t hold beyond six months or take a double-digit paper loss will regret it at some point in the future, even if they never admit to it.
