How to decide when to buy or sell stock investments

I’m writing an investment book called “Getting a Better Class of Enemy - Money, Markets and Manias”. As I write the chapters, they will be made available to paid subscribers to OfWealth. Previous chapters, along with the Preface and Chapter Plan, can be found by clicking on this link.

The reason for the title is that, as your wealth grows, there are a lot of potential “enemies” that will try to take it away from you. These are explained in Chapter 1.

“Money can’t buy you friends, but you do get a better class of enemy.”

Spike Milligan, Irish-English author and comedian (1918-2002)

A question that I’m frequently asked is when and why investors should make decisions to buy or sell stocks. This is also a question that I’m constantly asking myself, as I slowly rotate my own portfolio through the best opportunities that I find.

It’s unsurprising that a lot of investors are confused about what to do. Both standard investment theories and proffered financial advice often appear contradictory.

The reality is that different approaches make sense, at least to some degree, according to different investment strategies, and under different market conditions.

This chapter summarises the parameters that I use to make decisions to buy or sell. There are seven “Buy” scenarios, and seven “Sell” scenarios, which is a nice bit of accidental symmetry.

These range from how to invest a large lump sum, such as an inheritance, to when it’s appropriate to bite the bullet, swallow a loss, and move on.

In general terms, the scenarios should cover most situations that you’ll encounter, and help you to act with more confidence when making decisions. If you think of something that I’ve missed, then please let me know.

I hope that you find the chapter useful.

As always, feedback from readers is encouraged.

Please send emails to ofwealth@substack.com

I will reply!

“Indecision is the greatest theft of opportunity.”

Jim Rohn (1930-2009), author and motivational speaker.

“The most difficult thing is the decision to act, the rest is mere tenacity.”

Amelia Earhart (1897-1937), aviation pioneer.

“The greatest mistake you can make in life is to continually fear you will make one.”

Elbert Hubbard (1856-1915), writer, artist and philosopher.

Deciding when to buy or sell an investment is a common area of confusion for investors.

This is unsurprising, given the blatantly contradictory advice about “best practice” that’s found in financial literature and education.

Such advice tends to oversimplify appropriate courses of action via simplistic statements. But the real world of investing requires a more nuanced understanding of what to do in different situations.

This chapter aims to help you to make decisions about when to buy or sell stock investments according to a range of different circumstances.

To start with, let’s look at two, widely-touted examples of proclaimed investment advice - supposed “sacred cows” - that are clearly contradictory.

On the one hand, a common axiom in investing is that you should “let your winners run and cut your losers”. Some people have also phrased this as “watering the flowers but cutting the weeds”, or words to that effect.

In other words, if you follow this approach then you are always meant to hold onto things that have made a profit since you bought them and that remain in a rising price trend. But also that you should sell things that have made a loss, especially if they are in an apparent falling price trend that’s ongoing.

On the other hand, investors are also encouraged to re-balance their portfolios from time to time. This is in order to maintain target asset allocations and preserve diversification.

One example is the “Permanent Portfolio” model, which allocates an equal 25% to each of cash, bonds, stocks, and gold over the very long run.

(This is just an example for illustration, not a recommendation. Personally, I wouldn’t want 50% of my investments tied up in cash and bonds over the long run, given their exposure to the loss of buying power from currency debasement. And I wouldn’t necessarily want as much as 25% in gold either, although might do under the right conditions. Actually, on occasion - such as during the chaos of the Global Financial Crisis that began in 2007 - I had a substantially higher allocation to gold, albeit for a shortish time.)

The idea with this type of fixed-allocation strategy is to rebalance the investments at least once a year. That’s as the relative price moves alter the allocations in the portfolio, along with cash income received (interest, bond coupons and dividends), or after cash withdrawals are made (such as from a retirement fund).

This approach means selling part of whatever has done best, and buying more of whatever has done worst. Which is clearly the polar opposite of “let your winners run and cut your losers”.

Given this sort of contradiction, it’s unsurprising that investors get confused about the correct thing to do.

Personally, I believe that the best approach lies somewhere in between these two extremes. Individual decisions to buy or sell investments - especially when it comes to stocks - should be made on a case-by-case basis, but within some general parameters that I’ll set out below.

Certainly, you should aim to stay diversified at all times - both by asset classes (e.g. stocks as a whole) and within asset classes (i.e. different stock investments). This is crucial.

But the asset allocations should be dynamic, by which I mean you can tweak them according to market conditions.

For example, after a market crash it makes sense to have an allocation to stocks that’s higher than usual - in anticipation of a recovery as fear dies down. Conversely, it makes sense to lower your allocation to stocks in a historically expensive or speculative market, when there are few bargains available.

That said, for long-term investors, a very low or zero allocation to stocks would require extreme circumstances to make sense, such as the serious risk of a violent revolution or major war.

Sitting with 100% in cash or treasury bills and waiting for a run-of-the mill economic recession or market calamity could mean giving up years of profits before it happens. And if you don’t like your home stock market for some reason, you just need to cast the net outside of it. You’ll usually be able to find something attractive.

In any case, whatever asset allocations you choose should be adhered to with reasonable flexibility, and not cast in stone.

The reality is this: sometimes you should trim or remove winners, and sometimes you should add more to them. Sometimes you should buy more of the losers, and at other times cut them out of your portfolio entirely.

Just remember to stay sufficiently diversified at all times. This is a crucial overlay to all that follows.

(Chapters 26 and 27 will go into more details about how to achieve sensible diversification and construct an appropriately diversified portfolio. I also recommend being familiar with the contents of Chapter 6, which looks at our in-built psychological biases, Chapter 7, which warns against attempting short-term trading as a private investor, and Chapter 8, which examines risk and how to safely embrace it for profit.)