“I wish there was a quarterly review possible in a marriage,” rued my wife after a small fight. “I also wish there was an exit clause,” she added, this time raising my interest levels.
Long term investing is a lot like a marriage.
For a peaceful relationship, you must be willing to…
- Commit for the long term
- Keep your ego and emotions aside
- Keep your expectations realistic
- Learn to say ‘no’
- Learn to take the blame
- Know that things could change and accept when they do change
- Have immense patience
However, there’s one big difference between marriage and investing.
You must not enter into a marriage with the thought of divorce in the future. But you must always buy an investment with a clear-cut exit strategy.
Buy and hold ≠ Buy and forget
The most successful investors go into an investment with an exit strategy in mind.
While buying an investment, they have a clear answer to the question – “When will I sell this investment?”
Warren Buffett once said, “Our favourite holding period is forever.”
But given what Buffett has done over the years, perhaps what he meant was, “Our favourite holding period is forever…but, in practice, we will sell if any of a number of conditions is met.”
You see, buying a good stock and holding it for 5-10 years is a great idea. In fact, most books on sensible investing have advised this strategy for long.
In essence, I think it is good advice. But I think it can be misinterpreted to mean ‘buy and hold…and forget…and never sell’.
The results of such interpretational error can be disastrous for investors.
To avoid such disasters, here are 10 reasons I personally use to sell my stocks, however attractive the overall stock market might seem:
- When I realize that I made a mistake in buying a stock.
- When a stock gets overvalued (its price moves much higher than its intrinsic value).
- When the business model of a company deteriorates.
- When the cash flows of a company deteriorate.
- When the debt on a company’s balance sheet crosses my comfort level (usually 50% of equity) and is expected to remain there for some time.
- When something happens to cast doubt on a company management’s integrity (like a bad diversification, or an overvalued acquisition).
- When the return on equity falls below 15% with no sign of improvement.
- When the stock surges at a rapid pace without any change in the underlying business fundamentals.
- When I identify a better opportunity (I sell the worst stock from my portfolio and reinvest the money in this new opportunity).
- When I need money for an emergency (I start by selling the worst stocks from my portfolio).
The bottom line
I use this 10-point checklist to review my stocks every six months or as situations demand.
In fact, I have this handwritten checklist pasted in front of my workspace…and it acts as a great and regular reminder that ‘buy and hold’ doesn’t mean ‘buy and forget’ (this is however valid only for my stocks, and not for my marriage :-)).
What about you? Do you have a clear exit strategy in place when you buy a stock? If yes, what is it? If no, why not?