Why is it that selling a stock can seem so much harder than buying? We admit that we feel that way, and we suspect many other investors do too.
Rationally, it doesn’t make any sense because the process behind buying and selling are the same – two sides of the same coin, so to speak. But a recent working paper called “Selling Fast and Buying Slow” (Akepanidtaworn, Di Mascio, Imas, and Schmidt, 2018) confirms what many investors have long thought: Buying stocks is easy, but selling them is hard.
After looking at 783 portfolios and 4.4 million trades to analyze the performance of buys and sells separately, the paper found that portfolio managers display clear skill in buying, but not in selling. In fact, investor selling decisions are so poor that they underperform a no-skill strategy of randomly selecting stocks for sale -- say, by throwing darts at a dartboard.
That’s a striking result. How could it be that a skilled buyer isn’t automatically a skilled seller when buying and selling are analytically similar? If your practice is to analyze financial fundamentals and buy what is undervalued, then it seems that if you use the same fundamentals to sell what looks overvalued, you should achieve symmetrical results. And yet often it isn’t so.
One possible reason for this is that buying and selling are different exercises psychologically. According to the paper, portfolio managers rely heavily on a stock’s past return when making a sell decision -- but they do not do so when buying a new stock. For some reason, when considering a sale, past return becomes the most readily available piece of information that an investor reaches for. So while buying always is forward-looking, selling becomes backwards-looking.
That is something that’s likely to ring true for many of us. When you look anew at a stock that has dropped 20%, you tend to focus not on the price drop but on the fundamentals. But it’s a different story when you already own the stock. Suddenly, that 20% price decline makes the decision to sell, hold or add more difficult.
There are a few other interesting things here too: First, selling happens most often for stocks with extreme returns, either positive or negative, and that is often to the detriment of performance. The best and worst performing stocks get sold at a rate 50% higher than those with moderate returns -- and the portfolio managers with the greatest propensity to sell extreme-return stocks have the worst selling outcomes.
Next, selling decisions seem to be especially poor when investors are stretched or under duress because when things are going badly for the portfolio as a whole, sell decisions get worse even though buy decisions don’t.
And finally, it doesn’t appear that portfolio managers lack the fundamental skills to make good selling decisions. However, it is clear that they spend much more time thinking about buying than selling. Perhaps that is because they think their main job is to find the next great idea. Or perhaps buying is just more psychologically satisfying than selling. When you buy, the idea is fresh and optimism abounds. When you sell, you’ve already gotten mired in your own experience.
The good news is that when investors spend the time to think more about selling, they are able to port their fundamental skills over and achieve better selling outcomes. So one lesson here is simple: Just pay more attention to selling.
Another lesson is to think twice and then thrice before selling anything that has had either extremely good or terrible performance because the chances of making a mistake are especially high.
And finally, investors should find ways to keep looking forward instead of backwards when assessing stocks for sale. A recent Bloomberg Businessweek article noted that one fund takes away coverage from the original portfolio manager after a stock has had two straight quarters of earnings disappointments. That’s one interesting strategy to keep a fresh, forward-looking perspective on an underperforming stock.