The writer is co-founder and co-chair of Oaktree Capital Management
In 33 years of writing memos to investors, I’ve never dedicated one to the matter of selling. But I’m doing so now because it’s essential that we understand why many investors fail to focus on the long term and instead sell out.
As I wrote in a memo in 2015, I believe most investors trade too much and to their own detriment and that the best solution for illiquidity in markets is to build portfolios for the long term that don’t rely on liquidity and trading for their success.
I believe there are two main reasons why people sell investments: because they’re up and because they’re down. To understand this, you need insight into human behaviour, since a lot of investor actions are motivated by psychology.
A good deal of selling takes place because people like the fact that their assets show gains and are afraid these increases will go away. Thus they engage in “profit-taking”.
Most people invest a lot of time and effort trying to avoid unpleasant feelings like regret and embarrassment. And what could cause an investor more self-recrimination than watching a big gain evaporate? Instead, if you sell an appreciated asset that puts the gain “in the book” and it can never be reversed. But that’s not a sufficient reason to sell. Current fundamentals, their potential and the fairness of the asset’s price must be considered.
While I’m not saying investors should never sell appreciated assets and realise profits, it certainly doesn’t make sense to sell things just because they’re up. Also, I believe it’s usually a mistake to view realised gains as less transient than unrealised gains. Proceeds from sales are generally reinvested, meaning the profits — and the principal — are put back at risk.
As wrong as it is to sell appreciated assets solely to harvest gains, it’s even worse to sell things just because they’re down. While the old saw says we should “buy low, sell high”, clearly many people become more motivated to sell assets the more they decline. They worry about letting losses compound, but selling things just because they’re down is a mistake that can provide great opportunities to other investors.
Further, investors often engage in selling because they believe a decline is imminent and they have the ability to avoid it. However, there are very few people who possess the skill needed to profit from market timing. Additionally, buying or holding — even at elevated prices — and experiencing a decline is in itself far from fatal. Usually, every market high is followed by a higher one and, after all, only the long-term return matters.
Sidney Cottle, the editor of later versions of Benjamin Graham and David Dodd’s Security Analysis, introduced me to one of my favourite descriptions of investing: “the discipline of relative selection”. Every sale raises a series of questions, often surrounding relative values and opportunity costs. What will you do with the proceeds? Do you have something in mind that you think might produce a superior return? What might you miss by switching to the new investment? And what will you give up if you decide not to switch and continue to hold the asset in your portfolio?
Or perhaps you decide to sell and don’t plan to reinvest the proceeds. In that case, what’s the likelihood that holding the proceeds in cash will make you better off than you would have been if you had held on to the thing you sold? Selling an asset is a decision that absolutely must not be considered in isolation.
If you shouldn’t sell things because they’re up and you shouldn’t sell because they’re down, is it ever right to sell? There certainly are good reasons for selling, but they have nothing to do with the fear of making mistakes, experiencing regret and looking bad. Rather, opportunities for intelligent selling should be based on the outlook for the investment and they have to be identified through hardheaded financial analysis, rigour and discipline.
Most economies, companies and markets benefit from positive underlying trends. If investors use poor judgment and reduce market exposure through ill-conceived selling, they will fail to participate fully in those trends. That’s a cardinal sin in investing. It’s even more true of selling things in desperation after their prices have fallen, turning negative fluctuations into permanent losses and dismounting from the miracle of the long-term compounding of returns. What’s clear to me is that as opposed to selling for reasons of psyche, simply being invested is by far “the most important thing”.