Quick question: What's the fastest way to make millions in the stock market? Easy -- buy a handful of high-quality stocks and ride them to riches.
Unfortunately, it's not always that simple. Although investors may think they have a lock on knowing what and when to buy, more often than not they forget the flip side of that equation -- knowing when to sell.
Parting is such sweet sorrow
Although investors may be able to hang on to some stocks for years or even decades, fundamentals do sometimes change, and the reasons for owning a stock in the first place may no longer apply. None of us likes to admit that we're holding on to a loser, but investors need to examine their situations dispassionately. There's a big psychological barrier in place when it comes to selling stocks, so if you can get around that wall and let go of investments at the appropriate times, you'll be light-years ahead of most.
For example, take this year's sell-off in financial stocks. Falling housing prices and troubles in the mortgage market slammed financials across the board. This has been an equal-opportunity sell-off that has punished stocks regardless of whether their underlying fundamentals have been affected.
Put simply, times like these call on investors to re-evaluate their holdings.
Of course, remember the baby and the bathwater
There are some financial stocks that have been beaten down, but I still believe they have solid long-term prospects -- stocks like JPMorgan Chase (NYSE: JPM), American International Group (NYSE: AIG), and Wachovia (NYSE: WB). Despite the recent turmoil, the long-term bottom line is unlikely to be strongly affected at these companies, given their financial strength and operational diversification.
On the other hand, some companies have been inflicted with long-term damage from the credit market fallout. It's unlikely that UBS (NYSE: UBS), which has significant mortgage exposure, will revisit recent highs anytime soon.
In cases like these, investors may need to give serious thought to selling. And although many will want to hold in hopes of regaining some of that lost ground, it can be worthwhile to cut your losses and redeploy that money elsewhere.
Bringing in the backup
Of course, if you don't have the stomach for constantly reassessing whether it's time to sell your stocks, there is another solution -- investing in mutual funds. Why not let an industry expert worry about making the sell decision? After all, he or she generally has access to information, resources, and personnel that individual investors do not.
But the thing about funds is that you have to be selective. There's a lot of investing talent out there, but you have to sort through some not-so-good funds to find it. That's my goal at Motley Fool Champion Funds -- to sift through the mountains of funds and find the freshest money-making ideas out there. And our team has managed to do a pretty good job at it, too.
Know when to fold 'em
And if you want to talk about knowing when to sell, Ken Heebner, skipper of Champion Funds recommendation CGM Focus, shows us how to play the game right. The fund has wide latitude in determining which stocks to buy, but Heebner also keeps a careful watch on when to sell his positions. He will sell a stock if its investment expectations are not being met, if better opportunities are available, or if it has met its price target.
Using these criteria, Heebner made a call to sell back at the height of the tech bubble and thereby avoid the deep losses of the ensuing bear market. A contrarian at heart, he correctly concluded that many tech stocks were overvalued back in 2000 and 2001, based on traditional price-to-earnings and price-to-sales measures.
Predicting that these stocks would decline, he shorted many of those same companies, such as Global Crossing (Nasdaq: GLBC) and EMC (NYSE: EMC). He then rerouted money into more attractively priced value stocks, including a number of homebuilders, which subsequently took off.
That's just good money management
Despite all the hype of the late-1990s bull market, Heebner was able to objectively evaluate his holdings, general valuations in the market, and overall economic conditions and conclude that he needed to sell. Many people were too caught up in the outsized gains that tech stocks had produced in the previous couple of years to let go of their shares. But instead of getting tripped up by emotions, Heebner paid attention to valuations and other market fundamentals and read the writing on the wall. Most of us can learn something from this example.
These moves helped boost CGM Focus to a cumulative 86.9% gain during the bear market of 2000 through 2002 -- this at a time when the S&P 500 Index lost a cumulative 37.6%! Imagine having that expertise on your side during difficult market environments.
You can learn more about CGM Focus and all of our other fund picks by taking a free 30-day trial of Champion Funds.
This article was first published March 26, 2008. It has been updated.
Amanda Kish heads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned here. JPMorgan Chase is an Income Investor choice. CGM Focus is a Champion Funds recommendation. The Fool has a disclosure policy.
