By: Tim Bennett
07.02.2019
07.02.2019
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Why investors sell the wrong shares
Prominent writer and blogger, Barry Ritholz, has noticed something recently that is as interesting as it is worrying – professional investors are much better at buying, than selling, shares. Here is a summary of why and the implications for retail investors.
Background
It seems that when it comes to shares trades, we suffer what can be somewhat grandly called, an “information asymmetry”. We put a lot of effort into picking stocks but much less into the ones we later ditch.
The evidence
This is quite a bold claim to make but it is backed up by a sizeable piece of research into the investing decisions of professional (or “institutional”) investors that concluded that most would be better off selling stocks at random than applying their own selection criteria. This can be summarised as follows;
The process
This was no anecdotal piece of work, based around a few trades, but rather the result of a detailed study.
The clever part of this piece of work was the use of a counterfactual portfolio. In effect, to test the quality of individual buying and selling decisions, the authors compared the actual performance of a portfolio against its equivalent where buying and selling decisions were taken at random. On the buy side, they found that the average investor in their study demonstrated good levels of skill and could usually beat the randomised portfolio. However, on the sell side, the reverse was true.
The results
It is the extent of the discrepancy on the sell side that is eye-opening, as this slide reveals;
The key question is then – why is there such a difference?
Why we sell
The study’s authors reveal that investors often put a lot of time and effort into justifying a buy decision but later sell for unsystematic, and even lazy, reasons, such as;
What’s more, we tend to pick stocks to sell on a fairly irrational basis – quite often, it will be the best or worst performers that get the chop. As a result, either the cheapest stocks are jettisoned, or the winners in a portfolio. This can turn out to be an expensive mistake later, as the randomised portfolio’s outperformance reveals.
Why we should sell
A better approach is to apply the same discipline to selling as investors tend to when it comes to buying. In short, we should feel the same pressure to justify both decisions to ourselves.
How we can get better
A simple way to improve our focus on selling is to identify the opportunity cost (the gains foregone) from selling, after say one year. We should also have a set of criteria for both deciding when to sell and what to sell. That is easier said than done sometimes, as we tend to want to focus on new ideas rather than existing ones, but clearly it is worthwhile in terms of long-term portfolio returns. In a nutshell, don’t be a lazy seller!
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