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Debunking the Buy-and-Hold Myth
It’s tough to know when it’s time to sell a stock from your investment club portfolio, especially one that’s underperforming your expectations.
On the one hand, we’re taught that a buy-and-hold approach to the stock market has many advantages, so our inclination is to hold on to companies that may be experiencing temporary fundamental troubles. On the other hand, it’s painful to look at negative figures in the gain/loss column of your club valuation statement month after month.
Let’s debunk the buy-and-hold myth. Nowhere is it written that “buy and hold” means “buy and hold forever.” Nevertheless, academic research on individual investor behavior has found time and time again that investors are predisposed to hold losers for too long and sell winners too early (see Shefrin and Statman, 1985, and Barber and Odean, 2000). Individuals are optimistic about the stocks they’ve selected, and selling a loser stock is a definitive action that resolutely defines the original purchase decision as a mistake. But if you hold on to the stock, it might eventually, hopefully bounce back and prove you right.
In an investment club, reaching a consensus to sell a stock presents additional challenges. Members not only must overcome the tendency to hold a stock in spite of the facts, but they’ll also worry about personal relationships within the club. The member who first presented a stock to the club may resist efforts to sell if that company’s going through fundamental hard times. This is only natural — no one wants to feel as if he’s hindering the club’s success. Other members may talk delicately about selling out of fear of hurting someone’s feelings.
Despite these hurdles, there are a few techniques that clubs can use to avoid being encumbered by the emotional side of selling.
I call these “easy outs,” since they can help a club to reach a sell decision without getting dragged down in the muck and mire of personal feelings and uncertainty.
n Sell to take a capital loss. At the end of each calendar year, the club should review its current holdings with an eye toward selling stocks that the club’s holding at a loss. The idea is to match or exceed any capital gains realized in the year. Even though partnerships don’t pay federal taxes directly, members will report gains and losses on their personal returns, so it’s beneficial to members if the club manages its tax liabilities. Capital losses offset any capital gains realized in a year, and any excess — losses up to $3,000 — in a year are deducted from your ordinary income. Any capital losses above that are carried forward into future years indefinitely.
n Sell losers to pay off a club withdrawal. A partial or full member withdrawal creates a perfect opportunity for a club to clean house and dump underperforming companies in order to raise cash to pay out the member. (Remember, you don’t want to sell winners in the case of a full member withdrawal; see “The Clubhouse” in the June/July issue.)
In both of the above scenarios, it’s good to remember the line from David Gates’ 1970s hit “Goodbye Girl”: “Goodbye doesn’t mean forever.” You can schedule a new presentation about the sold stock for an upcoming meeting and see whether the club wants to invest in that company once again. (Chances are good that no one will be interested in going down that road again.) Remember that when selling at a loss, you can’t repurchase the same stock until the 31st day after selling or else you’ll run afoul of the wash sale rule, negating the capital loss.
Both of the above approaches also avoid creating negative feelings from the stock’s original sponsor, who may actually feel secretly relieved that the burden of defending a loser has been lifted.
Don’t use the word sell. Instead, think about “replacing” a stock with another and of “upgrading” your portfolio to increase its overall quality and projected total return. There are always possible replacements for the underperformers in your holdings, and smart clubs maintain a watch list (like the feature found in myICLUB.com) of high-quality growth stocks. Simply thinking of the sell decision in this light helps clubs to avoid holding on to problem stocks for too long and will pay big dividends over the long term.
Douglas is ICLUBcentral's product manager, helping develop the company's programs including Toolkit 6, myICLUB.com, and the Investor Advisory Service. He is also the author of several investing books, including The Pocket Idiot's Guide to Direct Stock Investing, The Complete Idiot's Guide to Online Investing, The Armchair Millionaire, and Investment Clubs for Dummies.