When to Leave the Party

Behind every potential investment, someone always is screaming in your face to buy. You have been told over and over again that it is good to pour money into investing. To hold an asset in hopes that in the future it will give you more value than what was put in. Not only are you told to do it, but you are advised on how to do it as well. We ought to be aggressive when we are younger and start investing early. We ought to invest at least a certain percentage of our paycheck each year. We ought to have this much in our accounts by this age to hit our goals. We ought to buy this one, not that one.

Behind all of this advice is only one key theme: entry. Being able to buy assets has been romanticized by modern culture in recent years, and recently developed technology has made this theme almost omnipresent. All the chatter and weight given to entry is for good reason too. After all, we are all given a finite time on earth along with finite resources, so we want to be as efficient as possible when it comes to investing and preparing for our future. However, this is only one of the actions actually needed for investing. Almost laughably, no pop culture books are written about when to dispose of our investments, no one brags about the potential losses they avoided by taking some losses early, and very few have an exit strategy for a position while almost all have a strategy for entering. This bias towards entry needs to be paired with a strategy for exiting as well, and this strategy should answer only one simple question. How do we know when to sell?

The first component that needs to be addressed is something we are all too familiar with, and that is ourselves. Almost immediately after entering a position, your brain will try to associate a kinship with it. You like the investment because you own it. Worse yet, if you have unrealized losses immediately the sunk-cost fallacy comes into play. You put so much time and effort into your job to make your money, spent time researching your ideas, have held on and watched for years, and now your investment is down. “All that for nothing.” This absolutist thinking only further harms your emotional and financial pain, and it is necessary we break free from it before moving on. Your motivations for entering into an investment should be the bedrock of your decision-making when evaluating whether or not it is time to sell.

Now that we have set the stage for emotions that may be present, secondly, in our process we need to audit. When we entered there was a reason we did so. We thought that something was so convincing we were willing to take on a risk in order to have it. Your money had very little risk sitting in the bank relative to an investment, so what was the catalyst that was so enticing? And is it coming true? Has the story changed? The easiest way to do so is to actively upkeep and weigh reality against your predictions. Checking reality against our thoughts is the key difference between having “hope” versus a “wish.” Hope has a likely runway to play out on, it is grounded in reality and is not only feasible but probable. A wish is based on emotions and is detached from the reality of the situation. Unfortunately, without proper stress testing the reason you entered into a position, the two look nearly identical.

Lastly, we are value investors. If we sell a position we should expect to extract some form of value from it. In a perfect world, all of that value would be given in financial gain. But as we know the world is far from perfect! So, in the absence of financial value, there are several others to be found during the selling process which can be drawn out. The first is a learning opportunity. Analyzing what went wrong and how to avoid it next time saves more in the long run than the impending loss. No matter how you look at it. Secondly is the ability to add potential value back into your investments. If there is a bad egg in the clutch, and after analysis, it seems like it will no longer produce anything, why keep it to watch it rot? No one is forcing us to hold onto the things which cause us pain, and instead, we ought to be able to let go in favor of a more attractive investment with a potential value that far outweighs our current situation.

Aside from these two reasons, there is a litany of others we can summon up to make the argument for selling. The skewed view which summarizes investing into one action of entry only further hindrances long-term performance. Equally as important as choosing the correct investment to enter into is the strategy for exiting it.

Warmly,

Zach Terpstra

Principal