I have been a DIY investor for the past few years and have developed strategies to build the value of my portfolio and keep the momentum going. For example, I will sell an investment and redeploy the funds when the stock reaches a 25-per-cent loss to my purchase price. I need your advice on a strategy regarding when to book gains, especially when many of the stocks in my portfolio have risen more than 50 per cent.
Warren Buffett said it best: “When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.”
Too many investors think the way to make money is to buy low, sell high and repeat. They see the stock market as a casino-like game that requires a strategy or trading system. But if you own a great company – one whose sales, earnings and dividends (if it pays any) are growing steadily – the best approach is often to do nothing.
Consider Amazon.com Inc. (AMZN). Since 2000, there have been three calendar years when the stock fell more than 25 per cent, and four years when it gained more than 100 per cent. The former would have likely qualified as sell signals based on your system. But simply buying and holding Amazon over the past 20 years would have produced a return of more than 24,000 per cent.
Granted, it’s easy in hindsight to point out the wisdom of holding a tech monster such as Amazon. So let’s look at a less extreme example from my model Yield Hog Dividend Growth Portfolio.
Over the past 10 years (through June 30), Algonquin Power & Utilities Corp. (AQN) has produced a total return, including dividends, of 411 per cent. That’s pretty good – it’s equivalent to a compound annual gain of 17.7 per cent – but it hasn’t been a straight uphill climb. During a six-month span in 2013, for example, Algonquin’s stock tumbled 25 per cent. Was that a good time to sell? Nope. It was a great time to buy: Over the next 16 months, the shares gained about 70 per cent.
Even after that large advance, the shares went on to roughly double over the following five years.
This is the problem with selling a stock based on how much it has gained or lost in the past: It’s backward-looking information that, by itself, tells you nothing about how the stock will perform in the future.
Ultimately, I believe the reason people sell based on past performance is emotional. When a stock rises sharply, they worry that it will give back some of its gains. When a stock drops, they worry that it will continue to fall. So they sell. More than anything, it’s a way to control their fear by applying what seem like rational rules to automate their decision-making and, in theory, limit their losses.
But over the long term, this approach will very likely cost you. You would be better off buying and holding proven, profitable companies – or diversified exchange-traded funds – and learning to ride the short-term waves without constantly feeling the need to do something.
That’s not to say you should never sell a stock. If a company becomes wildly overvalued and there is no justification for its price-to-earnings multiple, or if the business has taken what appears to be a permanent turn for the worse, those could be valid reasons to sell. But how much the stock has gained or lost since you bought it is not.
When ETF companies publish performance data for their funds, are the returns before or after fees? And do they include dividends?
Exchange-traded funds and mutual funds report their returns after fees, with all distributions assumed to have been reinvested in additional units. Similarly, when a fund company provides a benchmark return for comparison – such as the S&P/TSX Composite Index – it is a total return with dividends reinvested. Standardizing returns in this way allows for apples-to-apples comparisons between funds and with indexes.
Unfortunately, not all ETF companies thoroughly explain what their returns measure, which leads to confusion. Bank of Montreal and Vanguard Canada, for instance, refer to the change in “NAV” (net asset value) or “market price” of their ETFs, which may lead some readers to believe, incorrectly, that dividends are not included.
BlackRock Canada does a better job with its iShares ETFs. Its ETF performance tables include a clickable information button that brings up the following text: “Total return represents changes to the NAV and accounts for distributions from the fund.”
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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