Selling stocks when they are down seems to be one of the hardest things for some investors to do. There are a lot of reasons to hold a stock that is down, but it makes no sense to hold just to avoid selling at a loss. Luckily, mechanical investors have an easy way to decide when to sell a losing stock -- just follow the strategy.
Mechanical investors don't even have to make a judgment call. We just sell the stocks if they are no longer picked by our strategies when renewal time comes around. It's so simple. Why is it so hard?
The mechanical investor's enemy. Selling a stock when it is down means you have a real loss, not just a paper loss. It gives us that creepy, wriggly feeling that says, "You've screwed up." Who wants to listen to that?
There have been several questions on the Foolish Four and Workshop discussion boards in the past several days asking about selling stocks when they are down. A couple of Foolish Four investors were coming up on their renewal date and wondered if they were supposed to sell stocks at a loss. The general lament was: This isn't the way it was supposed to work!
Sadly, it is. Oops, another emotion.
Holding on to losers is an excellent strategy for progressively losing more and more money. Sure, sometimes they rebound, but the real question is, "Would my money stand a better chance of rebounding if it were in another stock?"
Tough question -- one that fundamental investors agonize over. Luckily, mechanical investing provides the answer. The stock screens pick the stocks with the best chance of going up. (They aren't always right, but we are playing the odds here, so they don't have to be right every time.)
I bought six stocks on October 2 as part of my Workshop rotation. One is up 20% this month, one is up 7%, the other four are showing losses ranging from 23% to 30%. That's in one month! As of close of trading on Friday, I have a 12% loss for that batch of stocks as a whole. However, I can honestly say that it doesn't bother me. I've had enough success over the last year-and-a-half with Workshop strategies, and I've seen the volatility along the way. So, when a month like this comes along, I barely give it a thought. I just hold 'em until they drop off the screen.
It's different when the bear roars on your first set of trades. Formerly rational people start to listen to that little voice that says: "You should have known better. Everything you invest in crashes. You're not competent to invest your own money. How could you have listened to a bunch of Fools?"
The more humorously inclined post something to the effect of: "I gave mechanical investing the kiss of death a month ago when I bought five stocks from the Keystone 100. The strategy is doomed. What will you guys give me to sell them and go away?"
Many people use bad times to reassess their investing strategies. Bad idea. Reassessing your strategies is a good idea, but not when the whole market is down. Especially not if you are reacting emotionally to your losses. Volatility is part of the game. The higher the returns, the more volatility you should expect. You did research your strategy before you bought it and were prepared for this kind of wild ride, right?
Anyone who has looked into the backtest of the Foolish Four strategy closely would have seen that the strategy has never provided consistent yearly returns. There were some impressively good stretches, but it has never beaten the market for 10 years in a row. The last time the strategy ended the year down was 1990.
I took a quick look at how the strategy has performed in years when the Dow lost money. The Dow (equally weighted and dividend adjusted) has had nine losing years since 1960. In four of those years, Foolish Four portfolios started in early January also lost money. Twice, the loss was greater than the Dow's loss. In 1990, the Dow lost 9% and the Foolish Four lost 18%.
However, during that entire time, only twice did the Foolish Four fail to beat the Dow during any five-year period.
For whatever value there is in a retrospective look at returns (and there is plenty of controversy about that!), it does tell us that there is nothing unique about what is happening this year, not to the market and not to the Foolish Four.
Given that we don't yet have the results of our out-of-sample test on the RP formula, the only basis for deciding whether this strategy is for you is the historical record and the rationale behind the strategy. I think it is a good strategy for picking undervalued, large-cap stocks. They haven't been very popular lately, though.
However, last week, which saw tech stocks ravaged, was terrific for the Foolish Four. After dipping into negative territory (negative as in a lower balance than we started with two years ago!), the strategy went up 9% for the week, more than half of that on Friday. Meanwhile, the Dow was up 3.5% and the growth-stock-laden Nasdaq was down 6% for the week.
One week's performance is meaningless, but what that week showed was something that seems to be repeating every time there is a growth-stock sell-off: The Nasdaq goes down, the Dow goes up, and the Foolish Four goes up much more than the Dow as a whole. That's the way it is supposed to work.
The problem is, lately these growth/value cycles have lasted weeks instead of years. I expect we will see a longer swing to value stocks at some point and, when we do, I would expect that pattern to last long enough to give up some good returns for a change!
Fool on and prosper!