It is said that nobody has ever lost money from selling at a profit.
Recently, an investment blogger wrote about a stock he sold after holding it for two years, netting a tidy profit in the process.
His post triggered a flurry of comments, mostly congratulatory.
The observation got me thinking.
Should we, as investors, exchange high fives every time we lock in a profit?
Are there really no downsides to taking our money off the table?
And if there are, what should be our considerations?
Is there a need to sell?
The most important question, in my eyes, you should ask is: why are you selling?
If the intention was to simply book a profit without any consideration for the future prospects of the business, then we may want to hold off on applauding such a move.
The temptation to lock in gains can cause investors to be irrational.
After getting a paper gain, some investors may be fearful of losing what they have gotten, therefore leading to a sell decision which is driven by emotions. .
This insecurity within their hearts pushes them to quickly “lock in their gains” so as to realise whatever profits they have.
And let’s not forget that selling for a profit also has the allure of bragging rights and may cause us to sell for the wrong reasons..
The downside, of course, is this: if you got rid of a truly great company too early, you’d be missing out on many years of compounding.
Take Alphabet (NASDAQ: GOOGL), the parent of Google, as an example.
If you had bought shares at around US$300 back in early 2011, you’d have enjoyed a more than eight-fold gain in a decade as the shares have surged in tandem with its profit.
Selling Alphabet too early just to lock in a gain would have been the wrong move, in hindsight.
A more attractive investment option
When an investor makes a sale, the funds gained will have to go somewhere.
If the proceeds are parked as cash in a bank account, the returns are paltry, typically less than 1% per year.
As such, the investor has to consider whether there is a better stock to put their hard-earned money.
If the money is not redeployed and simply sits idle, you may have been better off holding on to your original investment.
This is especially so if the investment pays a consistent yield that is close to or above the inflation rate.
Some investors may prefer to sit on the cash and wait for a huge correction or crash before committing their capital again.
Remember, though, that you should be a business analyst and not a market analyst.
Trying to time the market is a fool’s game, so the focus should be on the analysis of individual companies instead.
Long-term future prospects of the business
Investors who sell should also consider if they may be selling a company too early.
Companies need time and resources to grow, and patience is a virtue when it comes to unlocking the full potential of a great company.
Investors who sell their shares prematurely would lose out on a ton of potential gains should the company go on to do very well in the years to come.
Personally, I am sitting on a tidy gain from purchasing shares of DBS Group (SGX: D05) during the lows of the pandemic last year.
However, I have no desire to sell my shares as I still believe there is significant potential for growth in the lender’s business in the future.
The fact that it also pays out a quarterly dividend also means that I get paid to wait while its growth catalysts play out.
Get Smart: Selling for profit is not always wise
After considering the points above, I believe we should stop short of congratulating people who have locked in profits.
Although celebrating a gain may be a natural reaction, there are many implications of selling that may not be readily apparent.
Instead, we should study these investors’ rationale for making the sale and also review their subsequent capital allocation decisions.
If the redeployed capital went into a poorer investment choice, then the decision to shift the money may not be a good decision.
The investor would have been better off just sitting still and not doing anything.
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Disclaimer: Royston Yang owns shares of Alphabet.