This is one of the most difficult decisions one must make when managing a portfolio. Buying stocks is the easy part. Determining whether you stay invested in a particular company or in stocks, in general, is much more strenuous. With all the heightened volatility and doom and gloom news, it is likely something you are contemplating right now. It can be painful to hold through market corrections, and we often want the pain to stop. We know that we can sell, go to cash, and the pain we are feeling will temporarily go away. You can always repurchase stocks later. It may be at lower prices, say 10-20% lower, or it may be 10-20% higher. No one can know for sure. If you plan to buy back at all, this indicates you still believe in the long-term benefits of investing, and you believe stock prices will be higher in the future. So, unless you need all of your money in the near future for a large purchase, the best strategy has proven to be holding on to your investments and allowing them to work through the volatility. Remember, long-term gains are never achieved without short-term losses. Unfortunately, it is a packaged deal. What feels wrong today may be right a year or two from now. Most often, it is. Hence, we tend to avoid selling during periods of volatility, especially if you are set up in advance with the appropriate investment strategy to meet your goals.
The Income Investor
The income investor is someone using the cash distributions their investments generate to help supplement their income. You will often hear me compare this type of investing to owning a rental property. The house’s value will fluctuate depending on market conditions, and the rent checks provide you (the owner) with the cash you can spend on living expenses. The income investor likely owns a combination of dividend stocks, REITS, various types of interest-bearing bonds, preferred stocks, and the like. Typically, this investment strategy generates around a 4% cash flow yield. The cash flow yield is designed to provide investors with two benefits during periods of volatility: cash to spend immediately and time to allow their holdings to rebound.
Should you sell?
Pros:
You can potentially buy back in at lower prices if you sell now.
Buying at lower prices may increase your cash flow yield and provide higher income.
Temporarily relieve the pain of volatility.
Cons:
You risk buying back in at higher prices with a lower cash flow yield.
While you sit in cash, no investment income will be generated (no rent checks) so you will have to draw down your principal.
You may have capital gains taxes to pay if your holdings are not in a retirement account.
The Wealth Accumulator
The wealth accumulator is someone who does not require the income from their investments and has some amount of time before they will need it. Perhaps anywhere from 5-20 years before they switch to an income investor. They likely own more volatile stocks with greater upside potential like technology stocks or broad indexes like the S&P 500 or Russell 2000. The stocks they hold are companies with the highest revenue growth potential and offer innovative products or services that will be needed even more in the future. Any dividends paid will be reinvested to accumulate more shares to compound growth. Many wealth accumulators are systematically buying stocks each month through their 401k or brokerage accounts. Short-term volatility benefits an accumulator in the long term because they are buying shares at lower prices. The wealth accumulator’s most significant advantage is that time is on their side.
Should you sell?
Pros:
You can potentially buy back in at lower prices if you sell now.
You can potentially avoid major losses that take much longer to get back to even (Ex 50% loss requires a 100% gain to get back to even).
You can lock in previous gains, take the cash, and pay down debt.
Temporarily relieve the pain of volatility.
Cons:
You risk buying back in at higher prices and underperformance.
You may have capital gains taxes to pay if your holdings are not in a retirement account.
You must determine when the appropriate time is to buy back in.
You have temporarily halted the process of systematic compounded returns.
In summary, although we can make the case that selling stocks typically is not a good idea if you are an income investor or wealth accumulator, it does not take the short-term pain away. It is something that we as investors continually have to face and deal with. Sometimes the pain is too much, and you may feel that you have to do something because you cannot sleep at night. In those cases, I typically recommend raising cash by no more than 25% of someone’s holdings, with the condition that you understand that this will likely end up costing quite a bit of money in the long term. Worth it, if your health is being affected.
Remember, there is a difference between being an investor and a trader. We investors are forced to invest alongside a vast financial community that has evolved into a giant high-frequency trading platform. Most Wall Street institutions are primarily made up of traders inputting various factors and variables into computers with automatic trading algorithms. Unfortunately, it is not too different from sports betting, where odds are created, lines are generated, and trading rules are established and executed. Get in, get out, go long, go short, repeat often. It should be no surprise why volatility is much faster and more forceful when you have large amounts of capital with the lightning-fast speed of technology behind it. Only the most powerful trading firms with sophisticated computers can compete in this game. For the rest of us, we are playing a different game. One that requires us to view stocks as businesses rather than random ticker symbols. It is a view that requires even more patience and grit to stay the course when it is often quite challenging to do so. Long-term investing works, and it is typically our own behavior that disrupts the beneficial compounded results.
We understand these are emotional times and part of our commitment is to do our very best to help you with your major financial decisions. Our entire team stands ready in your corner if you should need to discuss your personal situation in more detail. Remember this too shall pass.