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Don’t lose everything by getting it half right!

Most investors are smart people but not full-time professional traders or investment advisers. Here is the most common mistake that those investors make:

They only have “half a plan.”

In order to make money on your investment, you need two good decisions:

  1. The decision to buy

  2. The decision to sell.

The savviest investor spends a lot of time on the decision to buy, which is great. The problem is that they spend very little time, if any, on the decision to sell.

Of course, the concept is to buy low and sell high, but what’s the target? If you don’t have a target, you will never know when you’ve achieved it. Without a target, even an investment that initially gains value can turn into a regret.  

A friend of mine lives in Silicon Valley. When tech stocks first started booming two decades ago, he bought the stock in one company for $8 a share. In time, it went up to $56 a share. He hung on to it. When the tech bubble burst, it dropped back down to $8 a share and he was exactly where he started.

When I asked him why he didn’t sell all or part of the stock when it hit $35, $45, or $55 a share, he said, “I thought it would still go up.” His decision was classic FOMO (fear of missing out) and possibly looking foolish by cashing in too soon. Unfortunately my friend’s story is all too common.

Let’s say you are comfortable that TECHNO is a solid growth stock, currently trading at $100 a share. Based on your research you expect it go up by 40% in the next 12 months, so you buy some. That’s a great return in any market, but especially in the one we’re in now.

A month later, TECHNO has gone up to $120 in the first month (a 20% return), and you are feeling pretty good about your stock-picking skills. What do you do? If you sell at $120, you risk missing out on possible additional profits, because you expect it to hit $140. There isn’t a clear right or wrong here, but I will tell you what I would do.

I would sell at $120 and lock in my one month 20% profit. Why? If I make 20% in one month, my annualized return would be 240% (20%  times 12 months). If I don’t sell, I have to be willing to admit that my decision is based on the belief that a 240% annualized return is not good enough for me. Can you look yourself in the mirror and say with conviction that a 240% annualized return is not good enough for you? I can’t.

While we all want to make more money, turning your decision inside out forces you to look at it objectively, which gives you valuable insight (and potentially saves you money and grief.)

Whatever you decide as an investor, in order to be successful, you need a PLAN… a plan on when to buy and when to sell.