Fisher Investments Reviews When You Should Consider Selling a Stock

Transcript

Ken Fisher:

One of the toughest things in investing is to know when to sell a stock. The reality is, you never really do. You just think you do and you conclude. If you knew, well, knowing implies near perfect information. And in capital markets you never really have even close to perfect information.

In capital markets, you're always taking a subset of the information that might be available, or that could be available if you had so much time to study it, and taking that subset and jumping to a 100% conclusion based on the subset. So, what are the subsets that you should think about?

Well, one of them is you bought this stock you had a basis for why you thought it was good for your future wealth. Now, look at it again and say, based on what the company does, was there something—not what the stock did, but what the company has done—is there something flawed in your original thinking? What did you miss?

If you missed something important that was negative, now you need to start thinking about how you get out. If it's important. On the other hand, if you didn't, and the stock is just bouncing around, up or down, well, volatility is just one of those things you wait your way through.

Now, some people are fond of, and I've done videos before critical of, stop loss orders. Stop loss orders are a mechanical function that says if the stock drops by x amount, you sell and get out. And I've written a lot about why that's actually a stupid idea. And actually it's injurious to your portfolio. But let me take this discussion a slightly different way.

Portfolio theory, as it should be done, was created as an intellectual construct. Shortly after I was born, by a guy named Harry Markowitz, where he basically described, and I'm going to put technical jargon into simple English, that what you really want in a portfolio are things that have similar long-term return objectives, but that bounce against each other to create a portfolio that, in the short-term, is more stable than if you had things that had those same long-term portfolio return expectations, but always moved up and down together.

This process of them varying against each other, or so called covariance, creates a more stable path to that long term return, creating less risk relative to trying to achieve it. So, what Harry Markowitz would have said is, the only reason to enter a security into a portfolio is that it improves the overall trade off of long-term expected risk versus how these things vary against each other to create shorter term stability.

Now, he said a lot more than that. I'm making that pretty simple. In so doing, your point should be to think, what is this stock or anything else you're entering into a portfolio, do toward that goal. That really is the right goal, to get a high expected return relative to the short to intermediate term risk you're taking.

And you ask yourself, why does this fit in? So, let me give you some examples. Let's say you think these kind of stocks, maybe, as an example of what's been hot this year, some of the communication services stocks like Meta or Alphabet, that is the parent company of Google. And these stocks have been hot.

You think they'll be hot. But those two they're going to largely move together. And so you say, okay, I think they're going to be hot, but what in the short term if I'm wrong? In the short term, if I'm wrong, what would instead do really well? Maybe I should own a little bit of that. But that has good long-term returns, just not, they do well at a point in time when those stocks do badly.

So, you're looking again for that covariance. In thinking that through, you got two features to think through as you move forward. One of them is, do I still think that the Google and the Meta are doing what I want them to do? Because if I don't, then there's no particular reason for me to own the ones that I have as a counter force against them.

And then the second is, if I still think Google and Meta—Alphabet and Meta—are going to do well moving forward, and I need a counterweight against them, are these two still likely to act based on what they're doing as that counterweight?

So, let me give you an example of what might change that. Good counterweights against those kind of stocks are pure telecoms. But what happens if you've got a company that's part telecom and part something else, and then they sell a telecom part?

Well, then it no longer fits. And then you need to plan your way to get out of that. The whole concept that I've been describing is variations of, does the thing still fit the goals you were looking for when you introduced it into your portfolio?

It's not about the short-term wiggles, it's about does it help you achieve that longer term expected return relative to the risk in your portfolio?

I know that sounds a little bit like this, but it's really the way you're supposed to think about what's in your portfolio. Let me go on a little more tangent on this.

The way most people think about investing, which is fundamentally wrong, is to think of it like they might think of a coin collection or a stamp collection. They want for each of the stamps that are potential in this set, whatever the country is or whatever the nature is, they want the very a really high quality stamp and a really high quality stamp and a really good one of these and a really good one of those, or the same with coins or the same with any other collection that they have. But in reality, those are all things that tend to again, move together.

In portfolio management of anything, you're not supposed to be thinking like it's a collection, although there's nothing wrong with collecting things.

That's a different topic. In investing, you're supposed to think about this concept that Harry Markowitz laid out of how to achieve a high, long-term expected return relative to the short- to intermediate- term risk that you're taking with the holdings that you have.

And the way to do that is to blend things together with that similar long-term return, but that move against each other in the short to intermediate return. And you want to look to see that those pieces are continuing to play that role in your portfolio. And if they are, they fit. And if they aren't, then you should need to look to get out. Thank you so much for listening to me.

Voice of Ken Fisher:

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