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Why Investors Sometimes Make Poor Sell Decisions

Written by Rita Silvan | Published on April 13, 2021

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Deciding when to sell an investment isn't always easy. Some would say that investors – both DIY and professional – are generally much better at making decisions about buying than selling, especially in times of market uncertainty. Although buying decisions may be top of mind, the data shows that mastering the art of prudent selling may be key to long-term investing success. Let's take a look.

Why Investors May Sell Too Early

The primary reason for selling too soon seems to be tied to a lack of attention. Even professional portfolio managers tend not to give their selling decisions enough attention, especially if a stock has done exceptionally well or poorly, or the manager feels stressed about poor portfolio performance. Not only that, but they would do better overall if they simply made their sell decisions at random. Those are the conclusions of a study by academics at the University of Chicago's Booth School of Business, Carnegie Mellon University and the Massachusetts Institute of Technology, along with the CEO of Inalytics, a data firm that measures investment skill. They reviewed more than four million stock buy and sell transactions made by institutional portfolio managers between 2000 and 2016. Selling decisions tended to be poor, with one exception: When managers made sales around the time that companies released earnings reports, their returns tended to be better. This implies the managers spent more time researching company fundamentals before making their decisions.

Why this lack of attention? The abovementioned effect may be a product of a number of phenomena:

Disposition Effect

Why do investors sell stocks that are doing well but hang on to stocks that aren't? According to a survey of empirical research by academics at the University of California, individual investors prefer selling winners over losers – a behaviour known as the "disposition effect" – so they may sell winners too soon and hold on to losers too long.

Action Bias

Behavioural psychology tells us that people have a tendency towards action versus doing nothing; this is called action bias. Pioneer researchers Anthony Patt and Richard Zeckhauser tie this heuristic to our hunter-gatherer ancestors. While immediate action greatly benefitted our forbearers, today this tool can sometimes prove a hindrance. For investors, this human predisposition toward constant tinkering can lead to impatience and a need to see quicker results — even when doing nothing may be the best course of action.

Media Coverage (or Lack Thereof)

The financial media often skews to reporting on buying, not selling coverage. Professional investors, economists and other financial professionals are often asked for stocks on their buy lists but rarely on what they are selling and why. The common emphasis on buying, and a general lack of coverage on selling, can leave individual investors with less information and guidance on making selling decisions.

Selling for the "Right" Reasons

When it comes to sell decisions, while emotion can lead you astray, logic is your friend. There are several rational reasons investors may want to sell an asset. Here are a few:

  • When an investor sees a better investment opportunity or needs money to meet financial obligations.
  • In some cases, a few investments may have risen so much that they now represent a large percentage of the portfolio. Trimming these positions will rebalance the portfolio back to the ideal allocation based on one's goals and risk tolerance.
  • Tax planning may be another good reason to realize capital gains or losses in a certain calendar year.
  • When the nature or the prospects of the underlying business have fundamentally changed from the time of the initial investment or it no longer serves the investor's goals.

Another tactic: Some investors circumvent the timing of sell decisions by pre-determining an exit price before making a purchase. This way, when the asset reaches the target price, the position is trimmed or sold to lock in gains — hence the saying, "Nobody ever lost money taking a profit."

RBC Direct Investing Inc. and Royal Bank of Canada are separate corporate entities which are affiliated. RBC Direct Investing Inc. is a wholly owned subsidiary of Royal Bank of Canada and is a Member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. Royal Bank of Canada and certain of its issuers are related to RBC Direct Investing Inc. RBC Direct Investing Inc. does not provide investment advice or recommendations regarding the purchase or sale of any securities. Investors are responsible for their own investment decisions. RBC Direct Investing is a business name used by RBC Direct Investing Inc. ® / ™ Trademark(s) of Royal Bank of Canada. RBC and Royal Bank are registered trademarks of Royal Bank of Canada. Used under licence.

 © Royal Bank of Canada 2021.

The views and opinions expressed in this publication are for your general interest and do not necessarily reflect the views and opinions of RBC Direct Investing. Furthermore, the products, services and securities referred to in this publication are only available in Canada and other jurisdictions where they may be legally offered for sale. If you are not currently resident of Canada, you should not access the information available on the RBC Direct Investing website.

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