The Holy Grail in investing is buying low and selling high. For the most part, investors who apply a meaningful effort to selecting securities tend to get the "buy" part of the equation correct. They often find solid businesses trading at fair valuations with promising growth ahead.
Unfortunately, the decision to sell securities causes most investors to stumble. There is no set rule of thumb on when to sell a stock. Some investors simply sell once the shares have gone up by a predetermined amount. The idea here is to lock in gains, and you can never lose money doing so. It's a terrible feeling to see one of your investments appreciate by 50%, then hold on longer only to see your gains disappear -- or even worse, find yourself sitting on a loss.
Different strokes for different folks
Life would be much easier if we could find those few truly great businesses that can be held for decades, earning stellar returns, and freeing us from thinking about selling. If we could find companies that would perform in the ways Coca-Cola (NYSE: KO ) , Altria (NYSE: MO ) , or Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) have over time, all we'd need to do is sit back and let the beauty of compounding make us rich.
While such great investments are truly rare, that does not mean there aren't plenty of opportunities that offer excellent returns over a multiyear horizon. While it's up to you to find investments you understand, you must realize that what you do after you make the investment is just as important as when you make the investment.
The market serves you, not vice versa
To say that the current market environment is volatile is an understatement. Just last week, the Dow Jones was down nearly 2% one day, and up more than 4% the next. I doubt very much that, over those two days, the actual value (not stock price) of most American businesses moved that dramatically.
The stock market crash of 1987 offers an even more dramatic example. After Black Monday, famed value investors William Ruane and Richard Cuniff, chairman and president, respectively, of the hugely successful Sequoia Fund, remarked:
Disregarding for the moment whether the prevailing level of stock prices on January 1, 1987 was logical, we are certain that the value of American industry in the aggregate had not increased by 44% as of August 25. Similarly, it is highly unlikely that the value of American industry declined by 23% on a single day, October 19.
While there is no exact science to selling stock, rushing to sell when markets are declining is usually not wise. More often than not, you come to realize that you have sold a good business cheap. If you've done your work and know the business, then wild gyrations in the stock price aren't as upsetting, because you know the true value of the business. Most investors would be surprised to know that during past recessions, stock market returns were just as likely to advance as decline.
The truth is, business operations do not move in rapid-fire fashion like stock market quotations. Furthermore, a quarter is not an adequate time period to fairly assess a business's operations. So how could a daily or weekly decline in stock price really mean anything?
Take a vacation
Poor selling decisions can drastically affect your investment performance. There's a huge difference between weakened performance during economic slumps affecting a solid company like Wells Fargo (NYSE: WFC ) , and deterioration in business fundamentals affecting Countrywide (NYSE: CFC ) . If the business is fine, then it's only natural for operations to cool down when the economy takes a breather. If watching stock prices decline makes your stomach churn, then power down the PC and head for the golf course or the beach.