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LONG TERM INVESTING

Should you sell an underperforming asset?

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By Dave Gow, Strong Money Australia

2024-02-024 min read

In this article, Dave Gow from Strong Money Australia covers how to figure out whether you should sell a lagging investment. It also features some important questions to ask yourself before investing.

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No investment is perfect.

Many of us have been in the following situation before…

You look at your portfolio. And month after month (or year after year), there’s that one investment that always seems to underperform the others.

Almost like it’s taunting you. You start wondering: “Why do I own this thing? Maybe I should just sell it.”

But how do you know if that’s the right thing to do? That’s exactly what we’ll discuss in this article.

We’ll look at how to deal with underperforming investments, and how to know whether it’s a short or long-term problem.

I’ll explain the decision-making process to help you figure out if you should sell, hold, or buy more.

And of course, we’ll cover the behavioural traps that often cause us to make the wrong choice. Let’s get started!

Why we contemplate selling

The first thing to understand is why we get the urge to sell in the first place.

This comes from something known as loss aversion. We naturally want to avoid loss, especially financial loss. But it’s been proven that losses tend to weigh on us more than gains do. In fact, estimates are that we experience the pain of loss 2-3x greater than the joy of gain.

How crazy is that? Losing $1 feels the same as gaining $2-3. This alone almost ensures most Aussies will never fully enjoy investing in the share market as much as less volatile assets like property.

So, in the highly liquid share market, when prices fall we have an urge to sell. We want to “stop the bleeding”. We see it as cutting our losses before they get worse. On the surface, this might sound rational.

Unfortunately, this is often the wrong thing to do. Not always, but very often. We’ve discussed when selling makes sense in a previous article here. This also applies not only to broad market falls, but shares that are underperforming the market too. In that case, we’re “losing” money relative to what we could have made in other options.

We also start to believe the underperformance has occurred because we picked a bad investment. But this isn’t necessarily true at all. Every good long-term investment has periods where it does poorly and the owner questions whether they should sell. That goes for shares in successful companies, diversified funds, even prime pieces of real estate.

Reasons for underperformance

To make sound decisions, we need to know why our shares are underperforming.

To figure this out, look at the broader picture. Is the share market itself doing poorly?

Many times that’s the main cause of frustration for investors. It’s not the specific investment they’ve chosen that’s the problem. Instead, it’s simply a weak period for the market. By the way, we’ve covered how to deal with downturns before here.

Understand, this is completely normal. The market might have positive returns most years, but certainly not every year! Periods of losses and poor performance are just something we have to accept as long-term investors.

But maybe that’s not the cause. Your share or ETF has been performing poorly for quite a while. Maybe it’s a specific country index which is lagging. Is something happening in that country that’s causing it to have poor returns? Or perhaps it was trading at a high valuation when you first invested?

Maybe it’s a thematic ETF , or a specific share you’ve chosen. Same thing there. Did you jump in after the price had already risen a lot? Or has some news come out which indicates the future isn’t as bright as expected for the company or sector?

Clearly, there are a lot of factors at play. Countless things can affect the performance of our investments. At this stage, you’ve identified whether it’s a genuine underperformer that deserves closer scrutiny.

Important reminder: Many individual stocks may never rebound (it may just stagnate or fall towards zero). Countries and sectors are more likely to even out in performance over time (known as “reversion to the mean”), given they’re diverse baskets which update themselves. They probably won’t go to zero either! Also, certain strategies like value, growth, and others will have lengthy periods of above/below average performance. So the right move may simply be patience and waiting for things to turn around.

OK, it’s underperforming. Now what?

Alright, I’ve got five questions for you to consider when looking at a lagging investment.

1- How long has the investment been underperforming? One year? Seven years? The longer it’s been going on, the more meaningful the information is.

2- How bad is the underperformance? Are we talking a few percent per year, or a 40% fall yet the market is up 50%? Very different. Again, the bigger the difference, the more meaningful that is.

3- What are you comparing it to? A specific market? A global average? Your other shares? Cash?

4- Are you including dividends and franking credits to compare total return? Or are you just looking at price growth? It’s important to include all return components to get a proper like-for-like comparison.

5- Has the investment been impacted by currency movements? Things like international index funds can look great (or terrible) over certain periods for Aussie investors, even if the underlying shares inside the funds are flat.

Let’s assume you’ve considered all that. You’ve got a share that’s been lagging for quite a while, and the underperformance is not small. Now we move onto more personal questions (yes, more questions!), to see if selling is the right strategy.

Personalising the approach

If the asset starts going up, would you change your mind? How much would it need to rise for that to happen? This indicates whether you actually still want to hold the investment and are just getting swayed by recent performance.

Is it reasonable to expect the underperformance to reverse? Or is it possible it’s a poor selection? Based on earlier points, a country or diversified index is far more likely to improve in performance over time than an individual share. Remember, most individual shares lag the market over the long term.

Next, if you did sell, how would the rest of your portfolio be impacted? Will it result in less diversification? Lower dividend income? Or would selling it mean your portfolio is actually better, simpler, and easier to manage?

Would reorganising the portfolio make it more (or less) in line with how you want to invest going forward? If you sell, what would the tax outcome be? A capital gains tax bill? Or a loss you can carry forward to offset future gains?

Now that you’re thoroughly exhausted and your brain is fried after these questions, it’s time for action!

Strategies for dealing with an underperforming asset

This might surprise you, but there are multiple ways you can deal with a lagging investment. The right answer depends on your answers to the previous questions, plus the psychological aspect: your conviction in the investment AKA how you feel.

Strategy 1: Sell completely. This often means you’ve completely given up on the investment. It’s also most common with individual stocks that just didn’t work out for various reasons. Conviction is gone, and you no longer have faith that performance will improve.

Strategy 2: Reduce size, invest elsewhere. This is most common with individual shares and riskier bets that have done okay, but no longer align with your strategy going forward. Or, your risk appetite has changed and you no longer want so much exposure to the asset. You still have faith in decent performance over time, but it’s no longer one of your favourite investments.

Strategy 3: Keep holding, but don’t add to it. This approach is most common with long held investments with built-up capital gains. You may still think the investment will do okay, and at least well enough to make the tax more painful than expected underperformance.

Strategy 4: Keep adding to it. This is most common with index funds and other diversified shares which are expected to perform well in the long term. You have faith things will turn around, your strategy hasn’t changed, and this is just one of those poor periods for that specific country or index. So, you take the opportunity to keep buying more shares during the weak period.

Final thoughts

As you can see, there’s a lot of factors at play here.

So the question, “Should I sell this share?” is damn near unanswerable to any other human. The answer “It depends” isn’t very satisfying to hear, but it’s the right one.

Different circumstances will lead to very different answers. Hopefully this post gives you a roadmap for thinking through any selling decisions you might face in the future. Only then do you know if you’re selling for the right reasons.

Having this framework will ensure your choice is based on the whole picture. Otherwise, your mind may just trick you into selling perfectly good investments, when you might be better off buying!

Until next time, happy long-term investing

Dave

WRITTEN BY
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Dave Gow, Strong Money Australia

About Dave Gow | strongmoneyaustralia.com Dave reached financial independence at the age of 28. Originally from country Victoria, Dave moved to Perth at 18 for job opportunities. But after a year or two at work, Dave became dismayed at the thought of full-time work for 40+ years, with very little freedom. To escape the rat race, Dave began saving and investing aggressively into property and later shares. After another 8 years of work, he and his partner had reached financial independence.

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