The Holy Grail in investing is buying low and selling high. For the most part, investors who apply a meaningful effort to selecting securities tend to get the "buy" part of the equation correct. They often find solid businesses trading at fair valuations with promising growth ahead.
Unfortunately, the decision to sell securities causes most investors to stumble. There is no set rule of thumb on when to sell a stock. Some investors simply sell once the shares have gone up by a predetermined amount. The idea here is to lock in gains, and you can never lose money doing so. It's a terrible feeling to see one of your investments appreciate by 50%, then hold on longer only to see your gains disappear -- or even worse, find yourself sitting on a loss.
Different strokes for different folks
Life would be much easier if we could find those few truly great businesses that can be held for decades, earning stellar returns, and freeing us from thinking about selling. If we could find companies that would perform in the ways ExxonMobil
While such great investments are truly rare, that doesn't mean there aren't plenty of opportunities that offer excellent returns over a multiyear horizon. While it's up to you to find investments you understand, you must realize that what you do after you make the investment is just as important as when you make the investment.
The market serves you, not vice versa
To say that the current market environment is volatile is an understatement. In early 2009, the S&P 500 was down as much as 25% after an almost-40% drop in 2008. Since last March, though, stocks have risen almost 70%. Do you really think that over such a short period of time, the actual value (not stock price) of most American businesses moved that dramatically?
The stock market crash of 1987 offers an even more dramatic example. After Black Monday, famed value investors William Ruane and Richard Cuniff, chairman and president, respectively, of the hugely successful Sequoia Fund, remarked:
Disregarding for the moment whether the prevailing level of stock prices on January 1, 1987 was logical, we are certain that the value of American industry in the aggregate had not increased by 44% as of August 25. Similarly, it is highly unlikely that the value of American industry declined by 23% on a single day, October 19.
While there is no exact science to selling a stock, rushing to sell when markets are declining is usually not wise. More often than not, you come to realize that you have sold a good business cheap. If you've done your work and know the business, then wild gyrations in the stock price aren't as upsetting, because you know the true value of the business.
The truth is, business operations do not move in the same rapid-fire fashion that stock market quotations do. Furthermore, a quarter is not an adequate time period to fairly assess a business's operations. So how could a daily or weekly decline in stock price really mean anything?
Take a vacation
Poor selling decisions can drastically affect your investment performance. There's a huge difference between weakened performance during economic slumps, which can temporarily hurt a solid company like Coca-Cola
The Fool owns shares of Berkshire Hathaway, which is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway, Coca-Cola, and Wal-Mart are Motley Fool Inside Value selections. Coca-Cola is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days.
This article, written by Sham Gad, was originally published March 18, 2008. It has been updated by Dan Caplinger, who owns shares of Berkshire Hathaway. The Fool's disclosure policy is always in the right place at the right time.