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How to Nail Down Your Profits: 20 Questions for a Disciplined Approach

by Donald Cassidy

How To Nail Down Your Profits: 20 Questions For A Disciplined Approach Splash image

To be successful, an investment must not only be bought well, but also sold right.

Until sale occurs, the apparent outcome is merely a tentative, paper result. A handsome profit can wither at any moment (due to sudden bad news or a market meltdown) until it is actually nailed down.

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About the author

Donald Cassidy was senior research analyst for Lipper Inc., a Reuters Co., from 1990 to 2006. He recently founded the Retirement Investing Institute, a nonprofit educational foundation, and is the author of five books on personal investing, including “It’s When You Sell That Counts” (now in its third edition). Contact the author at don@R-I-I.org.
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Properly, much attention is given to studying what to buy, but woefully inadequate energy is devoted to the hold/sell decision. Ironically this is backward, since dollars already invested are at more risk (and so deserve more attention) than cash not yet invested.

In this article, I’ll discuss how you can implement a discipline to your decisions on whether and when to sell. This is not the usual advice to use stop-loss orders or trim positions to restore intended allocation percentages. Rather, this approach focuses your plans for an exit strategy from the moment you enter a particular position—in an effort to overcome inertia and produce advantageous, coolly implemented exits.

Buying and holding reduces costs and taxes. But this approach assumes two critical points:

  • First, that what was bought in fact was a wise and well-priced choice and,
  • Second, that it continues to have unchanged virtue and value.

Given that we are fallible human beings and that the world constantly changes, both key pillars of long-term holding are logically fragile.

Once a stock is bought, two powerful but dangerous forces accost us. One is inertia, sometimes driven by busy lives and often induced by knowing that perfect results will be elusive no matter how hard we work at the investing craft.

The second deadly force putting capital at risk is ego: You can fall too much in love with your winners (which make you feel very smart), and turn away from problems that attack your self image in the hope that time will heal your wounds.

Too often, innocently intended buy-and-hold positions insidiously become groundless buy-and-“hope” positions. Holding is recommitting your funds for tomorrow without paying a buy commission.

The point is that the term “buy-and-hold” doesn’t mean hold forever; even long-term investors eventually must sell in order for their positions to be successful. Using a disciplined sell approach, you need to start thinking about this issue sooner rather than later. And the best way to implement this is by using a checklist—a list of 20 questions you need to answer about each of the positions you own.

First Steps: Assess the Climate

Before you confront the proposed checklist of questions designed to impose discipline and thus better shape your sell decisions, you should first assess the relevant prevailing investment climate. Realistic observations here will create a helpful directional bias regarding holding vs. selling the individual position.

For example, when reviewing a bond or bond fund, or an interest-sensitive stock like a preferred, utility, or REIT, you must assess the outlook for inflation and interest rates. If inflation is kicking up, if interest rates domestically and worldwide are rising, or if the Fed is signaling tightening moves, the major tide is running against your position, so your bias should be toward selling rather than holding.

As for stocks, if the economy is shaky, if the broad market has lately made lower lows rather than higher highs, if the company’s industry is becoming troubled—or if the market is extremely buoyant as in late 1999—again the big picture is signaling that, in an otherwise indifferent situation, your leaning should be toward a sale over holding. Conversely, more favorable prevailing major conditions would signal a beginning bias toward holding, before you examine the specifics of the particular stock.

How to Use the Checklist

As with exercises in self-help books on any subject, in order to be truly useful this questionnaire needs actually to be filled in—and in real time:

  • Each stock gets its own separate page, so make some blank photocopies in advance.
  • Keep these in a three-ring notebook over time, including beyond when individual sales have been completed. That creates a highly useful reference that can highlight patterns of strong or weak behaviors.
  • For convenience, separate the pages into two sections: Currently open positions in alphabetical order in the front (or in order of dates when they will approach 12-month holding status), followed by closed-out positions from latest to earliest in the back section.
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At the risk of being less than kind to our forests, it really is useful to have pages for presently active positions in two or even three places: your workplace, from where broker conversations or on-line trading will take place; at home, near your PC where market studying and decision making tends to occur; and in your broker’s office if you still use a full-commission rep, so that he or she also might spend time thinking about these issues and be able to help you back onto the right path should there be any straying from coolly logical thinking (a way to “earn” his/her commissions!). Once positions actually are closed out, move pages to your master study location at home. How soon and how often should this exercise be conducted for each stock held?

  • You should start a new questionnaire and fill in the answers to Questions 1 through 5 immediately when a new stock is bought.
  • Depending on your typical turnover rate, it is advisable to create a tickler system so that you review each position no less frequently than 90 days from the buy date (or at the target sale date noted in Question 4, if that is sooner).
  • If the review results in a hold decision, file the page for re-review at the date in Question 11.
  • Investors who tend to hold for less than a year, or who have positions in very volatile issues, should do reviews routinely, perhaps at 30 days rather than 90.

The 20 important questions you need to answer are provided first with considerable details on how they should be answered; on page 16 a fill-in-the-blank questionnaire is provided so that you can copy and use it on your own. [You can also print the questionnaire from the on-line version of this article at AAII.com.]

Evaluating Your Answers

Written responses to all questions are strongly recommended, for two reasons:

  • The required discipline of thinking through the issues in detail, and
  • Creation of an archival record that can be used for later reference, comparison, and learning.

Start filling out the sheet without delay, by entering the stock or fund’s name and symbol and answering Questions 1 through 5 immediately when the buy order is executed. If you fill it in immediately, there will then be no need to search back for data for Questions 1 and 2 and, more significantly, there will be no fudging of responses to Questions 3 through 5. Later, after you have held the stock for several months, answer Questions 9 through 11 with your responses to Questions 3 through 5 covered up. At this point, you want a current assessment of your thinking, and if you merely copy your previous answers, it will render the exercise useless. The quality of your sell-vs.-hold decisions will be enhanced by the honesty and rigor with which you carry out this process.

Note that these questions include a built-in bias toward making one feel a bit defensive about holding a stock. This creates a presumption in favor of selling when things have not gone as planned (and especially so if the big-picture climate described earlier is negative).

If a holding is not working, that position needs to be fixed. Like underperforming employees, stocks not working need to be put on strict probation or fired without delay—not given lots of slack and hope.

If time has gone beyond the period indicated by your answer to Question 4 (the target sale date), or if the stock actually has traded at or above your sell target in Question 3, something has gone wrong with your plan or execution: lack of discipline.

If there are differences between the answers to Questions 3 through 5 as compared with those for 9 through 11, study them again for an implied corrective action.

An affirmative answer to Question 15 (have there been negative surprises?) or to either part of Question 16 (did you ever contemplate a sale but not go through with it?) indicates lack of decisiveness or consistency in dealing with this situation. Either greed asserted itself when things went well, or denial arose as events turned sour.

It is only human (but not profit-enhancing!) to shift ground or rationalize in an effort to be tolerant of the stock’s performance (one’s own judgment) or of one’s less-than-perfect strategy and execution. Learn from past strategy executions, and make a special effort to avoid falling into this pattern again. Continuing to do what is most comfortable will not improve results and is likely to hamper them. Focus on locking in financial gains, not on protecting a bruised ego.

The heart of the entire matter is Question 18, which is answered in one of your periodic reviews (with your updated knowledge, would you buy this stock now?).

If this cannot be answered “yes” with total honesty and enthusiastic conviction (use the subpart of Question 9 as an acid test), then stop this deteriorating process by selling.

If you would not buy today, how or why can you envision others doing so? If other investors cannot reasonably be expected to be buyers, such failure of sponsorship and support forecasts lower prices logically ahead. So why are you willing to hold in the face of that expectation?

How to View Fees and Taxes

A quick word about commissions and taxes—never mentioned in the 20 questions or related discussion.

If commissions influence your sell/hold decisions, move to a broker where they are low enough not to matter to you. You knew when you bought that you’d pay a commission to sell—this is not new news. It is now only a rationalization or excuse for inaction.

Taxes are also widely featured in the financial media. Reality says, better for the bottom line to realize several well-executed profitable shorter-term sales producing above-average annualized gains and pay full taxes, than to hold blindly for the long term with a lower tax bill in mind. Did you ever refuse a paycheck because it is taxed at regular-income rates? By definition, taxes are small percentages of pretax returns, so the primary focus should be on gains. Only when the 12-month holding date is very nearby should possible tax savings be seriously considered as a reason not to sell immediately when your analysis says continued holding is not well justified. Remember: paying big taxes means you captured major profits.

Conclusion

Use of this questionnaire is not a guaranteed cure-all.

Nor will it make every position profitable.

But it will help impose closure on situations that are not working out as expected.

Use it to generate urgency by examining and overlaying the time value of money, and to remind you that a decision to hold should be an active and reasoned act of the mind instead of a lazy default.

‘Hold’ decisions should be every bit as deliberate as a choice to buy or to sell—minus only the need to telephone your broker or click your mouse on-line.

This questionnaire will serve as a reminder, guide, and prompting tool to sharpen decision-making skills and thereby improve sale executions. It will probably make you uncomfortable, especially at first. But as famous multi-step programs note, becoming unhappy with our present state is the first prerequisite for achieving positive change.

May a high percentage of your stock purchases become winners. But equally important, may you succeed in nailing down profits when they are available.

Hold vs. Sell: 20 Questions for Nailing Down Your Profits

At Time of Purchase

1) Date stock was bought?
2) What was the price paid? Was it purchased at the market price or with a limit order? Also for reference, what was the Dow Jones industrial average level at the time of purchase?
3) What is the target sell price, and the implied price-earnings ratio the stock will reach at the target price? Have you entered a sell order and, if so, at what price?
4) What is the target sale date? What is the calculated projected annualized return (using the target sale date and price, and the price and date when it was purchased)?
5) What events or changes should make this stock rise? Do you have any specific expectations regarding these events or changes?

Reviewing the Position at a Later Date

6) Are you currently more, less, or equally excited and sure about the company versus when the stock was first bought?
7) Have the events or changes expected in the answer to Question 5 played out yet? If not, is there still a concrete chance they will? If yes, did the stock go up at all on any related or partial news? If yes, did the stock reach your objective in Question 3?
8) What is the stock’s price now? Compare with answers to Questions 2 and 3; note also your answer to Question 6.
9) What do you now expect to happen fundamentally? Compare this with your with your answer to Question 5. If discussed originally with friends, relatives, or colleagues, would the stock again be discussed as enthusiastically now and be purchased today?
10) Based on your answer to Question 9, what is your current target sell price? Compare this to your answer to Question 3.
11) When is the current target sell price in your answer to Question 10 projected to occur? Compare this with your answer to Question 4. What is the new estimated annualized return (based on the new target sale price and date)?
12) What is the downside price risk from current price if nothing happens—that is, if the events or changes in your answers to Question 5 or 9 prove false or faulty?
13) Is the reward/risk balance favorable relative to current prices? Compare answers to Question 10 and 12 with the current price. Many strategists require a 3:1 or better expected ratio!
14) Where is the Dow Jones industrial average now? Compare this with the Dow level in answer to Question 2. Is the stock’s performance relative to the Dow surprising? Acceptable?
15) Have there been negative surprises from the company or its industry since your purchase? How, if at all, did these affect your thinking?
16) Since your original purchase, did you almost decide to sell, only to hold on for a little more? Was a mental or actual stop-loss point set but later reduced or removed as the stock weakened?

Analyzing Whether to Hold or Sell Now

17) Considering answers to Question 9 through 12, specifically why should this stock still be held?
18) With your updated knowledge, would you buy this stock right now, at today’s price?
19) Have you identified significantly better opportunities for purchases right now?
20) Does the answer to question 17 (why should the stock still be held?) square with your answers to questions 10, 11, 18, and 19?

  

Hold vs. Sell: 20 Questions for Nailing Down Your Profits

Stock Name ____________________________ Ticker_____________

At Time of Purchase

1) Buy date __________________
2) Price paid $____________ Type of order: Market ____ Limit____ DJIA__________
3) Target sale price $________Implied P/E (at target price) _______Sell Order (if any)$________
4) Target sale date _____________ Implied annualized return (based on target price)__________%
5) Specific events or changes expected that will cause stock price to rise________________________________________________________
___________________________________________________________

Reviewing the Position at a Later Date

6) Currently more, less, or equally excited about stock? ________________________
7) Have events/changes in Question 5 occurred?____
If no: Are expectations still valid?_____
If yes: Did stock price react on news?________ Did price reach target in Question 3?________
8) Current price $_____________
How does this compare with target sale price (see Questions 2 and 3; also note answer to Question 6)? _____________________________________________________
9) What do you now expect to happen? ____________________________________________
How does this compare with answer to Question 5? __________________________
Are you still enthused enough today that you would buy it again?____________________
10) Based on your answer to Question 9, what is your current target sale price? _____________
How does this compare with your original target sale price (see Question 3)?_____________
11) When do you expect your new target sale price to occur? _______
How does that compare with your prior target sale date (see Question 4)?
What is your revised annualized return (based on new target price and date) ___________________
12) What is the downside price risk (based on today’s price) if events/changes do not occur as you expected? $_________    ______%
13) Is the current reward/risk balance (answers to Questions 10 and 12) acceptable (i.e., greater than 3:1)?_______
14) DJIA today ______ How does this compare with answer to Question 2? ___________
Is stock’s performance relative to the Dow surprising? _______________
Is stock’s performance relative to the Dow acceptable?_______________
If relative performance is not good, why is it acceptable?__________________________________________
15) Have there been negative surprises from the company or its industry since purchase?_____
How did these affect your thinking? _______________________Why/why not?_______________________
16) Did you ever almost decide to sell, but held on for ‘a little more’? ___________
Did you set a mental or actual stop-loss but later reduce or remove it as stock weakened?_______

Analyzing Whether to Hold or Sell Now

17) Based on answers to Questions 9 through 12, specifically why should this stock still he held?
_____________________________________________________
_____________________________________________________
18) With updated knowledge, would you buy this stock now at today’s price? Yes _____ No _____
19) Do you see any significantly better buy opportunities right now?____________________
20) Does answer to Question 17 square with answers to Questions 10, 11, 18, and 19?_____
If, no: Act!

Donald Cassidy was senior research analyst for Lipper Inc., a Reuters Co., from 1990 to 2006. He recently founded the Retirement Investing Institute, a nonprofit educational foundation, and is the author of five books on personal investing, including “It’s When You Sell That Counts” (now in its third edition). Contact the author at don@R-I-I.org.


Discussion

Jim from NY posted over 3 years ago:

I could not print this, save it, etc.

Anyone know why?


F from KS posted over 3 years ago:

Just copy and paste into a word processor. I found it very easy. If you do not know about copy then highlite with your mouse and press Crl C then go to your word processor and hit CTL V and that will paste it into the WP and you can save or print it out.


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