We continue to advise that you shouldn’t let the current or recent investment situation play too big a role in setting your investment objectives and investment strategy. Instead, try to pursue what you might call an “evergreen” investment approach.
You want to invest in such a way that you profit in good times, but don’t suffer too badly during the inevitable market setbacks. Above all, you want to make sure that you don’t make the mistake of losing out on some of your best investments.
When a bear market strikes, it’s natural to wonder if you’d be better off to automatically sell any stock you own that falls by some fixed percentage, perhaps 20 percent. That way, you’d never wind up owning any stocks that have fallen 50 percent to 80 percent or more, as some do in a bearish phase.
This would have been a great practice when a bear market was getting started in the summer of 2007, or in early 2011 when the market embarked on a downturn. But few if any investors have that great a sense of market timing.
In fact, many investors try to cut losses only after a big market drop. This protects them from big market declines after most of the big declines have already taken place. But it also stops them from cashing in on the inevitable market recovery that follows every market decline.
To Profit From Gains You Must Be Able To Accept The Declines
One key problem is that stocks generally are volatile. Stocks that are headed for above-average gains often show above-average volatility. A stock that is headed for a gain of, say, 500 percent over a period of years may first go through a series of declines of 20 percent or more.
If you sell the first time such a stock falls 20 percent, you are unlikely to get back in and profit from the 500 percent rise. Instead, you may buy some other stock—and sell it during a temporary 20 percent setback.
When a stock we recommend goes down, we try to figure out why. Often, the drop reflects new developments that hurt the immediate outlook. But the stock may have dropped enough to offset the bad news. If so, it of course makes sense to hold on to it or even buy more. However, investing comes with an unavoidable random factor.
The next development may be the release of good news, which can spur a temporarily depressed stock to reverse course and begin to rise. Or, news of further negative developments may spur a depressed stock to fall even more.
When bad news makes what we see as a lasting change for the worse in a stock’s outlook, we change our advice and advise you to sell. But selling simply because the stock has dropped virtually guarantees poor long-term results, if not losses. It will lead you to lock in temporary losses in some of your best stock picks.
My Investment Advice
Look on weakness in a stock as cause for concern and further investigation. But don’t sell just because a stock went down. Doing so could protect you from further losses, but in the long run it is more likely to have the effect of limiting your profits.
Courtesy Fundata Canada Inc. 2014. Patrick McKeough is president of The Successful Investor Wealth Management Inc. This article is not intended as personalized investment advice. Investment vehicles mentioned are not guaranteed and involve risk of loss.