Buying Low And Selling High? This Investing Legend Thinks You’re Doing It Wrong

Buying Low And Selling High? This Investing Legend Thinks You’re Doing It Wrong
Carl Hazeley

about 2 years ago5 mins

  • According to Oaktree Capital’s Howard Marks, you shouldn’t generally speaking sell stocks just because they’ve risen to lock in profits, or because they’ve fallen and you’re cutting your losses.

  • But there are two reasons to justify it: if you’re wrong about the fundamentals, or if there’s a more compelling investment opportunity you need the cash for.

  • Ultimately, it’s more important to be invested in markets for a long time than it is to time your buying and selling of certain assets.

According to Oaktree Capital’s Howard Marks, you shouldn’t generally speaking sell stocks just because they’ve risen to lock in profits, or because they’ve fallen and you’re cutting your losses.

But there are two reasons to justify it: if you’re wrong about the fundamentals, or if there’s a more compelling investment opportunity you need the cash for.

Ultimately, it’s more important to be invested in markets for a long time than it is to time your buying and selling of certain assets.

Mentioned in story

Oaktree Capital’s Howard Marks is a renowned name in investing circles, and his latest memo has got investors talking because of his views on when to sell your stocks. Because according to Marks, the old investing adage “buy low, sell high” has a major problem that’ll rob you of long-term returns.

What’s the problem?

Marks thinks investing’s more complex than boiling it down to selling up when stock prices go up.

Now, it’s true no one ever goes broke taking a profit, and it’s also proven that you’ll feel more pain from seeing your investment in the red than pleasure from seeing it in the green. So it’s completely understandable that when a stock you’ve bought is significantly up, you want to sell at least some of it to lock in your profit.

But when you do that, you’re losing out on something Albert Einstein reportedly called the eighth wonder of the world: compound interest – the effect of your early profits earning you even more over time. Here’s an example: the S&P 500 has produced an estimated compound average return of 10.5% a year for the last 90 years. A dollar invested in the S&P 500 90 years ago would be worth about $8,000 today, despite the index’s ups and downs along the way.

Marks, then, thinks you shouldn’t sell at all.

… Why not?

According to Marks, there are only two good reasons to sell a stock you’ve bought: if the fundamentals – think revenue and earnings growth – aren’t playing out as you’d hoped, or if there’s a better investment opportunity out there.

On the first point, if your investment thesis seems less valid than it did previously or it’s become less likely that your forecasts will come to pass, selling some or all of the stock makes sense.

On the second point, you’re trying to overcome “opportunity cost”, and the hurdle is a high one. You could justify cutting your investment in favor of another one that offers a higher potential risk-adjusted return, but you’d have to make peace with your analysis given that you might miss out on returns in your current investment.

So should you rebalance?

Marks’ view here is pretty straightforward: rebalancing is pretty unjustifiable for the short term, but there may be a place for investors rebalancing for the long term.

Investors with a short-term mindset may try to sell off stocks when they expect there to be a dip in prices. There are a number of reasons Marks isn’t buying it. He argues:

“Why sell something you think has a positive long-term future to prepare for a dip you expect to be temporary? Doing so introduces one more way to be wrong (of which there are so many), since the decline might not occur.”

Charlie Munger – vice chairman of Berkshire Hathaway and Warren Buffett’s right-hand man – agrees. He’s said that selling for market-timing purposes actually gives an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.

But Marks takes it one step further and argues that it could be three ways, “because once you sell, you also have to decide what to do with the proceeds while you wait until the dip occurs and the time comes to get back in.”

And of course, what if you’re wrong and there is no dip? Then you’ll have missed out on the gains that followed, and either never get back into the stock or do so at higher prices.

What about long-term rebalancing?

Virtually all investors diversify their portfolios, but they don’t do it because they lack confidence in their long-term winners. They usually do it to protect against what they don’t know or what they get wrong. So diversifying and rebalancing to maintain that portfolio diversification is, to Marks’s mind, making the deliberate choice to invest suboptimally: trading off the chance of a great return to increase the chance of just a good one.

Individual investors, Marks concedes, may have legitimate reasons for limiting the size of any one investment – not least their own risk tolerance. But he maintains that you shouldn’t sell just because an asset’s price has risen and the size of the investment has grown. Ultimately, it’s a judgement call.

So what’s the opportunity here?

The big opportunity, according to the memo, is simply in being invested – and being invested for a long, long time:

“What’s clear to me is that simply being invested is by far ‘the most important thing’. Most actively managed portfolios won’t outperform the market as a result of manipulation of portfolio weightings or buying and selling for purposes of market timing.”

Take Amazon as an example: everyone wishes they’d bought the stock at $5 on the first day of 1998, since it’s now up 560 times at about $2,800. But unless you were thinking about the really long term, you might’ve sold in 1999 when the stock was up 17-times to $85 in under two years. You might’ve cut your losses when the price dropped 93% to $6 in 2001, or locked in your profit at $600 a share in 2015, having seen the stock rise 100 times its low. But if you’d sold then, you’d have caught less than 20% of Amazon’s overall rise since 2001.

Admittedly, it takes a lot of initial and continuous deep and detailed research to build the conviction required to hold any stock for over 20 years. Failing that, your best bet is to buy the market as a whole, via, say, an exchange-traded fund tracking the S&P 500. That way, you don’t have the burden of making big bets on individual companies, but you’re invested in a way that’ll allow you to profit from the strongest companies’ stocks over time, driving the market higher and offsetting the weakest ones.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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