Buy and hold or buy and sell?

Dawid Botha, Financial planner at PSG Wealth Winelands.

In a perfect world, your initial share analysis will always be correct, and shares in your portfolio will be held for the long term. The reality is often different and investors do not hold shares forever.

Using the investment guru Warren Buffet as an example, investors often assume that Buffet “buys and holds” all his investments for the long term. An academic study, published in 2010, for the period from 1980 to 2006 indicates that Buffet’s Berkshire Hathaway only held 7 of the 230 shares owned during this period for more than 12 years. There is more detail behind this statement, but according to the study he sold more than 80% of the shares within 5 years of purchase. “Buy and hold” for a lifetime did not happen for this period, as is often believed.

It is critical to have a sound process and discipline for the purchase decision, but the same applies for the sale decision. It is empirically proven that more behavioural factors play a role in the sale decision. Logical and knowledgeable investors can sometimes knowingly or unknowingly make irrational and inconsistent decisions that hamper performance. As Goethe said: “To think is easy. To act is hard. But the hardest thing in the world is to act in accordance with your thinking.”

There are various behavioural traps. In terms of the sale decision, this includes biases that the investor has in the processing of new information that differs from the initial view (purchase decision). It is often painful to interpret new information that differs from one’s original assessment. Sometimes investors suffer from loss aversion. In such cases investors may not fully weigh and analyse negative expectations and hold on to a loser and hope that the investment will improve in the future.

Investors often also suffer from overconfidence. This partially originates from our memories frequently being selective and only remembering our successes. When we review situations, we often see outcomes as obvious, when our initial assessment was more uncertain. We tend to think we have more control over results than we actually do, and overweigh our assessment of potential outcomes. On the other hand we want to avoid regret and will then refrain from selling a share out of fear that we may miss out on performance. A combination of these issues may cause investors to hold on to excellent performing shares that become too expensive. These shares mostly revert back to their intrinsic valuations which can result in severe underperformance and permanent capital loss, especially if the share was in a price bubble.

The above mentioned are only some of the behavioural stumbling blocks that investors need to consider. It is clear that buying and holding shares in “good” companies, is probably an inadequate investment strategy.

Sale decisions can be determined by a single or a combination of factors such as price-earnings-ratios, profit declines, change in management, cash flow deterioration and share price behaviour. In order to be a successful investor one has to know the different factors, measure them correctly and apply that process consistently. If a disposal process and discipline do not exist, behavioural factors might take its toll on investment performance. Working with a personal portfolio manager can help investors to formulate the processes and disciplines to overcome these kinds of challenges, and achieve better investment outcomes in the long run.