Do you know when you should sell an investment? – 04/08/2024 – From Grain to Grain

Deciding the right time to sell an investment is one of the most complex dilemmas faced by investors. Often, this decision is hampered by emotions, breaking news, and the pressure of keeping up with market movements. Fear of missing out on an imminent rally or holding on to an asset during a deep drop can lead to hasty decisions. Those who think that the decision of when to buy an asset is more difficult are mistaken; when selling is much worse.

This is reader Natalia’s dilemma. She wrote to me: “We often see tips and guidance about the best investment, which one is yielding the most, etc., but I would like to know when it is necessary to get rid of something, which one to choose?”

A pragmatic approach to the sales decision involves defining clear objectives and a well-structured investment plan.

This means knowing why you purchased a particular asset and under what circumstances it would be appropriate to sell it. In other words, when you invest, you should already know under what circumstances to sell.

For example, consider that you invested in a security referenced to the IPCA. After 2 years, rates have fallen sharply and you have a good profit. Should you sell already?

It is possible to list three justifications for making the sale. The first could be by reaching a price target. Another strategy would be to rely on specific rebalancing deadlines. Finally, fundamental changes in the company or investment and the economic scenario could justify the sale.

Returning to the example. If there was no imbalance in the portfolio due to a greater appreciation of the security purchased, there would be no reason to sell for this reason. If you expect interest rates to continue falling, there would also be no reason to leave money on the table by leaving early.

But, imagine that you believe that interest rates could rise again in the short term. This could be a good justification, as raising rates could consume part of the gains obtained. Also, if you believe that interest rates have already dropped as much as they should and the risk of maintaining it is not worth it.

Exiting just because you made some profit can be a bad decision if there is still potential for the asset’s price to rise.

Regular monitoring of each investment is crucial, but this does not mean reacting to every market fluctuation. Instead, periodic reviews to assess how the investment is performing against its initial objectives can provide a stronger basis for decisions. This discipline helps you avoid the common pitfall of selling assets that are temporarily underperforming but without a fundamental reason for selling.

For example, you invest in a security referenced to the IPCA and soon afterwards the rates rise and the security presents a loss. Just because it fell in price doesn’t mean it’s now a bad investment. If the investment thesis remains, you need to be patient.

Remember, the portfolio must be evaluated in an integrated way. Evaluating each investment individually may result in the loss of diversification benefits.

A useful technique is portfolio reassessment, where investments are periodically adjusted to maintain an asset allocation in line with the investor’s risk profile. This process can naturally lead to selling investments to rebalance the portfolio, but it is based on strategic principles rather than short-term reactions.

Another critical point is the danger of falling into the trap of always selling assets that have the worst return, which can lead to a cycle of selling low and buying high. This is often the result of an attempt to avoid losses, but ironically it can result in an erosion of long-term earning potential. Instead, a careful analysis of the reasons behind an asset’s performance can reveal whether a sale is justified or whether it would be better to hold on to the investment.

Ultimately, the decision to sell an investment should be based on a combination of objective factors, such as investment goals, rebalancing strategies, and fundamental changes, rather than emotional reactions or market timing.

Taking a disciplined, principled approach can not only help you maximize returns but also maintain peace of mind as you navigate the complexities of the investment market.

Michael Viriato is an investment advisor and founding partner of Investor’s House.

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