When do you actually make money in the stock markets?
- When you buy the right stocks?
- When you hold the right stocks for the long term?
- When you buy at lows?
For such a simple question, the answer is even simple.
You actually make money in the stock markets when you sell. Whatever you see in your portfolio before that are unrealized gains.
However, it is not buying but selling, which is the most difficult for equity investors. They either sell too early or too late. They often sell the right stocks and hold on to dud investments, hoping for a turnaround.
While reading about investing, we stumbled upon an article. The article presented an interesting illustration to explain the concept sell too early.
A renowned investor and fund manager, Howard Marks writes, “Everyone wishes they’d bought Amazon at $5 on the first day of 1998 since it’s now up 660X at $3304, but who would have continued to hold when the stock hit $85 in 1999 – up 17X in less than two years? Who among those who held on would have been able to avoid panicking in 2001, as the price fell 93%, to $6? And who wouldn’t have sold by late 2015 when it hit $600 – up 100X from the 2001 low? Yet, anyone who sold at $600 captured only the first 18% of the overall rise from last low.”
Mark’s questions are valid – Who would have held Amazon through such gyrating movements? Perhaps only the Amazon founder Jeff Bezos and a few promoters who truly believed in the business idea would have held onto the Amazon stock.
Most investors sell when they feel they have made enough returns from a particular stock. It is called profit-booking and investors believe doing so locks in the gains. It is a common saying among equity investors no one ever lost money by booking a profit.
It makes profit booking sound like the easiest thing, even a 5th grader can do it. But as we mentioned above, selling is not that easy. The cause of such behavior lies in human psychology, and not logic. People are afraid to lose out on their profits. Exiting the investment at a high is a rush unlike any other.
Marks says, from an investment perspective too, booking a profit is another way of timing the markets, something that seldom works in your favor.
Warren Buffett’s business partner, Charlie Munger explained that timing the market gives an investor two ways to be wrong – the decline may or may not happen, and if it does, they’ll have to look for a time to get back in. Unfortunately, booking profits and avoiding a decline just creates an impression of success.
What works the best is to buy a stock with strong fundamentals, hold on to it for a minimum of 3-5 years and allow it to grow and multiply. Long-term gains are the best when you can enjoy the fruits of compounding. Essentially, the longer you hold the stock in your portfolio the higher the growth potential.
Selling when you have made a little profit or selling to ensure you book your gains in the near term does not help you create sustainable wealth. The wealth you can bequeath to your future generations is possible only when you invest for the long term.
What do you think, is buying difficult or selling?
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