Many people believe that knowing when to buy is much simpler and easier to do than when to sell. However, the real reward in investing comes from making smart buying decisions. Selling simply allows you to realize your gains (or losses).
Far too many investors overemphasize the selling process. In doing this, they subconsciously approach the investment process backwards. They are first focusing on achieving gains, when they should in fact focus on preventing permanent losses of capital.
You must first crawl before you walk
Before you think about when to sell, you must first learn when to buy. More specifically, you must first learn to buy stocks that offer good value. If you focus your efforts on seeking out investments selling at a discount to intrinsic value, the odds are favorable that when you need your money, you will sell at a higher price.
During this process of buying and selling, investors often stumble by confusing buying a business and buying a stock. When buying something cheap, investors often take that to mean buying the stock at the bottom. This is flawed thinking. If you happen to invest at the bottom, consider the event a stroke of luck rewarding your diligent efforts for investing in a bargain investment. But you can still make plenty of money, even if you miss out on the lowest stock price.
Similarly, investors assume that if they sell at a profit only to see the share price advance further, then they made a mistake by selling too soon. But that too reflects the wrong perspective.
Don't complicate a very simple process
First of all, anytime you sell an investment at a gain, you have succeeded. I learned at an early age that you will not lose money by selling something for more than you paid for it. So, if that's the name of the game, then mastering the buy side is how you win the game. Warren Buffett once remarked that "investing is simple, but not easy." It's simple in that all you need to do is find a handful of great businesses selling at reasonable prices and let time do its thing. Yet investing is not easy because most investors have a hard time doing precisely that -- sitting still.
Famed value investor Mohnish Pabrai once told me that two things occur to him after he makes an investment: When he buys, the stock usually dives, and after he sells, the stock rockets. Yet in the almost nine years that he's been running the Pabrai Investment Funds, he's boasting an annualized return above 20% -- after fees.
Widespread pain
Right now, I'd bet any serious investor -- individual or professional -- is sitting on at least some unrealized losses. Famed investor Bill Miller is taking a beating from his large positions in Countrywide (NYSE: CFC) and Bear Stearns (NYSE: BSC). Eddie Lampert, a brilliant capital allocator by many measures, has seen the share price of his company Sears Holdings (Nasdaq: SHLD) decline by nearly 50% over the past year or so. In the case of Miller, a very strong argument could be made that Countrywide and Bear had more serious problems and maybe he acted too soon. Still, Miller's track record speaks for itself, and I'm not planning to take the other side of any of his trades anytime soon.
Keep it simple and easy
So if you've done your work and found a solid company trading at an attractive price, don't be afraid to pull the trigger. Avoid leverage and let time be on your side. If the stock price declines after you buy and nothing has occurred to fundamentally alter the business, don't hesitate to back up the truck.
But if something occurs that fundamentally changes the future prospects of the company -- as is arguably the case with MBIA (NYSE: MBI) and Ambac (NYSE: ABK) -- then don't hesitate to cut your losses and run. In the case of the bond insurers, while they may survive, it is very likely their future profitability will fall severely, in part due to the inevitable new regulation that will likely arise from this mess. If this happens, then the intrinsic value of their businesses will be a lot less than before. That doesn't mean that MBIA and Ambac can't be good investments, but it does mean that you have to get a much better price than you might have paid previously.
All investors make mistakes. But if you do your work, odds are you won't make many big ones. And those who really do their work and stick to what they know make a lot less of them.
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