Quick question: What's the fastest way to make millions in the stock market?
Answer: 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
Investors may be able to hang on to some stocks for years or even decades, but fundamentals can 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 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.
Don't forget the baby and the bathwater
Some financial stocks have been beaten down but are still well-positioned for the long term. I'm thinking of a company like State Street (NYSE:STT), for instance, which is off more than 20% from its 52-week high. Even battered Morgan Stanley (NYSE:MS) and Merrill Lynch (NYSE:MER) -- both of which have been cut in half since last summer -- still have strong brands (Interbrand ranks both among the top 40 global brands) and operational diversification. While the subprime problems that caused their stock demise are still quite real, over the next decade or more, Merrill and Morgan should be able to right the ship.
On the other hand, some companies have been inflicted with long-term damage from the credit-market fallout. It was unlikely that Countrywide Financial (NYSE:CFC), which has significant mortgage exposure, would have revisited its recent highs, thus explaining its buyout offer from Bank of America (NYSE:BAC).
In cases like these, investors may need to give serious thought to selling. And although many will choose to hold, hoping to regain some lost ground, it can be more worthwhile to cut your losses and redirect that money elsewhere.
Bringing in the backup
Of course, if you don't have the stomach to constantly reassess whether it's time to sell your stocks, here's another idea -- invest 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 there's a caveat to funds: You have to be selective. There's a lot of investing talent out there, but you'll have to sort through some not-so-good funds to find it. That's my goal at Motley Fool Champion Funds -- I 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
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 the 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 avoided 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 them, such as Level 3 Communications (NASDAQ:LVLT). He rerouted the 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 evaluate his holdings, the general valuations in the market, and the overall economic conditions objectively, and he concluded that he needed to sell. Many were too caught up in the outsized gains that tech stocks had produced in the previous years to let go of their shares. But instead of getting tripped up by emotions, Heebner paid attention to valuations and other market fundamentals. He read the writing on the wall. Most of us can learn something from his 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 , CFA, directs the Motley Fool Champion Funds newsletter service. At the time of publication, she did not own any companies mentioned. CGM Focus is a Champion Funds recommendation. Bank of America is an Income Investor selection. The Fool has a disclosure policy.
