You're About to Make Your Worst Mistake Ever

As the stock market keeps rising toward levels we haven't seen in more than a year, anxious investors have begun to wonder whether it's time to start taking profits on their hard-fought gains. Yet even though fear of a future downturn is certainly justified, giving up on stocks when you have confidence about their long-term prospects could well cost you a big portion of your profits.

Won't get fooled again
Right now, many investors feel as though the stock market has given them a second chance. After seeing their portfolios take a huge hit earlier this year, the recent rally has given quite a few of those investors a new lease on their financial lives. The last thing anyone wants to do is to squander their second chance by getting greedy and holding onto their stocks for too long.

That combination of fear and anxiety may have you sitting in front of your computer, mouse poised over the sell button of your online broker, wondering if now's the best time to sell. Yet even though protecting profits seems like a reasonable thing to do, selling probably isn't the smart move if you've chosen the right stocks.

The price you pay
It's true that by periodically taking profits, you can protect yourself against unexpected financial catastrophes among the stocks you own. If you bought shares of GM or Lehman Brothers and held them forever without ever taking any profits, then you lost everything. At least those who took out some of their money along the way had something to show for their experience at the end of the day.

Much more often, though, taking profits merely cuts your potential gains on the best stocks you own. To see just how big an effect profit-taking can have on your portfolio's value, I took a look at seven stocks that have performed reasonably well over the past five years. In particular, I compared the experience of a buy-and-hold investor who put in $10,000 in 2004 and let it ride, versus a more active trader who took profits or bought more shares to get back to the original investment each year. Here are the results I got:

Source: Yahoo! Finance.

That's a lot of money to leave on the table.

Now, before you conclude that taking profits is always a dumb move, keep one thing in mind: Most of these stocks didn't see huge drops during the 2008 bear market. Any strategy that sold shares at lofty 2007 price levels and bought them back at much lower levels during 2008 showed some impressive profits. So clearly, if you're convinced that a stock is particularly overvalued, then selling shares is often the smartest move you can make.

The usual winner
More generally, though, stocks you own go through much more gradual cycles. Sure, from time to time, the market will bid up shares to the point where they may look expensive, while other times, investor apathy or scorn may push prices down to a temporary low. If you try to take advantage of those gentle moves by taking profits on your shares, however, you can easily get yourself into a position in which the market moves against you -- and it isn't immediately clear how to get back into stocks that you think are attractive for the long run.

Investing long-term isn't the most exciting thing in the world, and it certainly doesn't compare to the rough-and-tumble activity that comes from buying and selling stocks on a regular basis. Often, though, the only one who benefits from frequent trading is your broker -- and you would have been better off just leaving your portfolio alone through the ups and downs of the market.

Everybody likes easy money. Let Paul Elliott point you toward the easiest money you'll ever make.