Market Moves

It’s easy to buy a stock.  You can listen to a hot tip, do some research, be persuaded by a broker or even throw a dart at the stock tables in the newspaper.  But how do you know when to sell?

Selling a stock is much harder because you never hear a tip at a cocktail party or from your neighbor to sell a stock.  And high-priced Wall Street analysts rarely issue sell recommendations.  In fact, Credit Suisse currently has only 19% of the stocks they cover rated “Sell,” so you shouldn’t rely on analysts for timely advice on when to sell. 

If a stock is down, it’s hard to accept and acknowledge that the money is lost.  And if a stock is up, will it go higher? 

Here are some rules for determining when to sell.

Can you give a simple, reasonable explanation of what each company that you own stock in does?  You don’t have to know the quarter to quarter earnings comparisons or the current status of their debt, but you should understand what a company does to earn its profits.  If not, sell.  I can explain quite easily what products Procter and Gamble sells to earn money.  On the other hand, there is CytRx.  Even though I can explain that they are a biotechnology company, I still don’t have any idea of what they actually do.    

Don’t get emotionally attached.  Hope and prayer will not make a stock go up.  Is a stock down because of overall market action?  Or headlines in the news that will in the long run have minimal impact?  There have often been sell-offs of drug company stocks because one drug in their pipeline didn’t pan out.  One drug is not going to make or break Pfizer or Merck. 

Is the stock down because of fraud or criminal activity on the part of the management, like Nortel or Fannie Mae?  If so, then sell. 

Be wary of a sudden shift in gears.  A company that is struggling may only falter further when it invests in areas outside its expertise.  A business in one industry the buys a company in another should be analyzed with extra scrutiny.  Are these two business lines compatible and does the acquiring company have the expertise to integrate the acquisition?  One example would be Time Warner buying AOL in 2001 and now planning a spin-off to rid itself of the business.  Clearly, shifting from one business to another could be cause for concern.

Don’t sell the winners.  People tend to sell their winners and hold on to the losers.  In my portfolio, I’ve held most positions for years.  If the company continues to increase in value, I want to continue to reap those benefits.  Also, if I sell a company I know a lot about, I have to find a replacement that I can comfortably admit I know as well or better. 

Some stick to a rule such as “double and out,” or when a stock doubles, sell it.  I don’t agree.  If your comfort level dictates that you would like to lighten the size of your position, but you still want to own the stock, sell enough to equal the amount of your original investment.

I was looking at the stock market opinion and analysis website called Seeking Alpha the other day and these were the two most popular articles:

1. The Market Bubble is About to Pop
2. Why This Rally Will Continue

The first article gave many reasons why the stock market is “headed for major trouble” and the “economy is far from being out of the woods.”  The author cited substantial long-term headwinds and the irrationality of the recent rally.  He said there will be a realization that higher-earnings will not materialize any time soon.  Slow growth and higher commodity prices were also predicted.  And he meant every word.

The second article outlined why these “green shoots” we keep hearing about will turn into plants and how “less bad” is actually pretty good.  The second author wrote about how higher than expected earnings have provided the market with positive momentum.  He also wrote that GDP growth is projected to be positive in the third quarter and more earnings “beats” could propel the market higher.  He even admitted that although growth coming out of this recession would be slow, this is already priced into the stock market.  And he also meant every word. 

It struck me as funny that the two most popular articles offered diametrically opposed opinions about whether the stock market was going to go up or down. 

Most of the information you read about the financial markets from day-to-day are often written by very intelligent and knowledgeable people, but when you add up all their intelligent, but contradictory, commentary, it tends to be just “noise.”  The information could be valuable if you are a day trader, but more often than not, focusing on this daily noise usually leads to making irrational investment decisions based simply on fear or greed. 

My opinion is that a long-term view is important.  The importance of having a long term strategy and disciplined approach to fulfilling that strategy to investing for the long-term cannot be overemphasized.  So, ignore the daily noise and stick to a strategic investment plan with a long time horizon and you’ll be better off in the long run.

Over the years of working with different types of clients, I’ve realized that they all want to work with an advisor who possesses certain qualities.   The following criteria are the qualities that a good investment manager should have.

Be accessible.  You may be a fan of voicemail but eventually you want to speak to a real person and you want to speak to someone who knows you.  I pay good money to my accountant, so when I have a question or concern, I speak to my accountant, not his clerk or receptionist. 

Tell the truth.  Do your candidates have answers to every question?  Are they truthful about what they know and more importantly, what they do not know?   Will they tell you what you need to know early on, so you won’t be unpleasantly surprised down the road?

Be knowledgeable about financial evaluation.  If a manager professes to know about investing and the market, go hear them speak or read some articles or analyses they have written.  Does what they say make sense?  Do they speak in English or financial gibberish?

Have a consistent, understandable philosophy.  The best investors in the country, people such as Peter Lynch or Warren Buffet, may have different investment philosophies.  Lynch, author of several books on investing and former manager of the Fidelity Magellan Fund, looks for undervalued growth opportunities.  Buffet, of Berkshire Hathaway fame, looks for value-oriented investments with a strong franchise.  While they have different philosophies, they share one critical ingredient: whatever their philosophy, they never detour from it.  They are disciplined in sticking to what they know best. 

Have a system of monitoring and reviewing portfolios.  The advisor should have a formal and consistent schedule for reviewing your portfolio.  One of the chief deficiencies of a stock broker or commission based advisor is that they are product-oriented and not portfolio-oriented.  They look at the investment instrument rather than the balance of the total portfolio.  Lack of balance can provide a nice bounce if a stock gets good press.  But the bounce can end in free fall when the headlines are negative.

Be reasonably priced.  The advisor’s fees should be fair to both the client and the advisor.  The SEC does not regulate how much an advisor can charge.  The SEC only specifies that the fee schedule be stated to the client.  This means that the advisor can charge whatever a client is willing to pay.

Be in the growth phase of their career.  Do you want a surgeon who is youthful (but not inexperienced), dynamic, excited about his or her profession, always learning new things and sharing his or her knowledge with others?  Or someone who is thinking about retirement, slowing down his or her practice, and not always keeping up with the latest procedure or technique?  If you want the latter, you might as well put your money under the mattress, because an investment manager needs to have all the energy of a surgeon, if not more. 

Have an exceptionally clear view of reality.  This may be the most important criterion of all.  We have heard that in the real estate market, everyone is a genius when the market is going up.  This is true with other investments.  But it takes realism to recognize that elevators go in two directions.  And knowing when to get off is as important as knowing when to get on.

Life is full of risks.  Some risks like having surgery or driving on the highway are unavoidable.  But even though some risks cannot be avoided, they can be greatly reduced by eliminating the unknown.  In the case of having surgery, you will be much better off knowing the background of your surgeon, her success rate with the operation, as well as her reputation and medical standing.  By driving defensively and knowing your route ahead of time, you reduce the risk of accidents.  By doing your homework up front and identifying the issues and eliminating the unknown, you can better understand your limitations and manage risk.

To handle your money and investing successfully, some fundamental homework is also needed. First, take stock of your financial fitness. A few evenings at the kitchen table with a year’s worth of cancelled checks, credit card receipts and ATM  withdrawal slips will provide you with enough information to create your balance sheet and income statement. This hard knowledge of facts and figures will help you determine a rational plan for budgeting, planning and investing.

Money is intimidating. Making decisions about money is even scarier. In your home, on your job or in your business, you make decisions all the time without hesitation. You control, to the best of your ability, your fate. You strive to have the freedom to make decisions about the direction your life is going, how you spend your days, how you spend your money.

We’ve all taken risks at one time or another and succeeded. The risks were controlled. We try to avoid stupid decisions. We do our homework. But so much falls through the cracks when it comes to money. 

It’s all a matter of knowledge. That doesn’t mean knowing the answer to every question. It means knowing to ask questions. It means eliminating as much of the unknown as possible.  And when in doubt, subject your proposed investment to the following tests:

The Risk Test: If you awaken at night, concerned about the safety and permanence of your investment, you have assumed too much risk. Hype, glamour and excitement in investments more often than not are the result of smoke and mirrors. At different stages in your life, some risk may be acceptable. It will depend upon many factors including your net worth – there is no substitute for wealth – and your emotional capacity to weather uncertainty.

The Gambling Test: If you have the urge to gamble with your money and wish to speculate, take $300, go to a casino and get it out of your system. The stock market is neither a savings bank nor a casino substitute. Investing requires diligence, patience and discipline.

The Broken Egg Test: No matter how wonderful an opportunity sounds, never place all your assets in one basket. Diversification is the magic word. Every portfolio must be diversified to reduce the overall risk. To buy one municipal bond or one stock is foolish. If you can only afford that one investment, you don’t belong investing. Some mutual funds though, can satisfy many investment needs of the small investor. A quality fund with stable management, a good history, and reasonable operating expenses is inherently diversified even for those who are investing a small amount of principal.

The Microwave Test: If you spent as much time organizing, planning and learning about your money and investments as purchasing a microwave, you would be in good shape. The purchase of a microwave is a $100 decision that only affects the speed at which you can make a melted cheese sandwich. Yet, many people will be easily swayed to plunk down $10,000 because of a slick, high pressure sales pitch about an investment they know nothing about. The Internet, libraries, bookstores, magazines and cable TV are crammed with information on investing. Money magazine is another good place to get a feel for the language and basics of investing.

The Professional Test: When you are ill, you seek medical advice. When you are stymied with your tax return, you seek an accountant. When you need financial assistance, find a good financial advisor. Follow the same steps to find a financial advisor as you would a dentist. Ask your friends for referrals. Check the advisor’s credentials. Ask for references.

The Final Test: Preserve your capital. Keep pace with inflation and protect your purchasing power. Don’t expect miracles and home runs overnight. Don’t do anything that doesn’t make sense and feel right.

The mere thought of investing may seem risky to you. Investing and risk need not be synonymous. But risk is relative. Doing nothing is very risky. Doing your homework, following these straightforward rules, and expanding your knowledge reduces risk dramatically.