There are many good reasons to hold stock investments over long periods of time. Maybe you know that 10-, 20-, and 50-bagger profits come only to those who wait. Maybe you are avoiding tax penalties. Maybe you're just lazy.
Whatever your reasons, you are probably doing the right thing. Great investors, from Warren Buffett to Phillip Fisher to Peter Lynch, all stress the rewards that come from holding investments and avoiding the temptation to bail out simply because the markets are weak or a stock seems "too extended."
Of course, there are reasons you'll eventually sell. Some are personal -- if you need money for retirement, a house, or your child's education, for instance. That's the reason you're investing in the first place, right? But what about the other times, when it makes sense to get out of a position as a strategy to maximize the returns of your portfolio?
No, I'm not going to talk about valuation or tax considerations. I am going to talk about perhaps the only good strategic reason to ever sell a position: When the reason you bought it no longer holds true.
That can happen for many reasons. Maybe your initial assumptions about the company were wrong and new information -- or old information you failed to see earlier -- has led you to realize it. Or maybe the story that made the company attractive no longer makes sense -- its business or industry has deteriorated, new technology has supplanted its products, it has been outmaneuvered by competitors, or it has simply entered a new phase of life.
Usually, this happens slowly. Perhaps you bought Sun Microsystems
Such transformations are usually spread out across years, or even decades. The "story" you bought when you made your initial investment will eventually change, but probably only over a long period, giving you time to react if change is in the air.
That sickening moment
Sometimes, a story changes overnight. If you've been investing for a few years -- particularly in volatile areas like biotech, nanotech, or other emerging technologies -- you've probably experienced that sinking feeling in your gut that comes from finding your favorite stock down 20%, 30%, or more on a single event. Sometimes it's just the stock that has gone down. Other times, your investment rationale goes down with it. Your brain is screaming at you to do something quickly, but you don't want to follow the crowd by selling on an impulse. Will it keep dropping? Should you buy more?
I really hate having to make quick decisions. That's why I prefer the stakeout approach. A long-term investor can and should shrug off most moves in the market, but that doesn't mean you can take your eye off the ball. You should stake out every stock you own, tracking all the mundane information that, added up over time, makes those quick decisions easier.
In our Motley Fool Rule Breakers service, we're (metaphorically) holed up in grimy apartments across the street from each and every one of the 24 companies in our portfolio, gazing out the window through binoculars while our editor occasionally goes out for donuts.
Let me give you a couple examples. Back in April, Rule Breakers recommendation Provide Commerce
Even given some recent weakness, Provide Commerce is up more than 33% since Rick decided not to bail.
Things got hot again in July when Great Wolf Resorts
Part of the Great Wolf story we bought was that it would be able stay ahead of competitors without running up too much debt. That story weakened so much after the second quarter that we jumped ship -- and now Great Wolf has sold its original flagship parks in Wisconsin Dells, Wis., and Sandusky, Ohio, where competition is thickest. Sure, it may make sense not to continue slugging it out in a market that has 18 water parks within 19 square miles, but the move doesn't offer much evidence that Great Wolf can distinguish itself from competitors. We'd already watched the stock fall 31% on the day of the announcement (when Rick, again on duty, made the call).
Since we got out, Great Wolf is down a further 38%.
Maybe forgive, but never forget
Could a vigilant stakeout of your investments have told you to, say, buy more Cerner
The Cerner example is fairly straightforward -- its competitors were desperately undercutting it on price, but in a way those companies couldn't sustain for long. Holding on was a cinch. The Tenet example is more complicated -- in part because what was really going on at the company didn't become clear until long after the first signs of funny business. I don't think anyone had a clear idea what reforming its billing procedures would cost the company in terms of profits.
It was clear in the days following the announcement that the company would most likely be investigated by Medicare. When you play fast and loose with your No. 1 customer, which has the power to change the rules about how much it will pay you, I want out. If that wasn't clear enough, there was history. Long before HCA
None of this stopped me from feeling queasy during the plunges, of course, but it made knowing what to do next a lot easier.
Karl Thiel is a member of the Motley Fool Rule Breakers team. If you'd like to test-drive Rule Breakers for 30 days at no cost, click here for a free trial. You'll have full access to every buy report ever made, and there's no obligation to subscribe.