The key to overcoming the market is knowing what and when to sell. Still, even most investment professionals fall seriously short when it comes to selling.
This is the finding of an academic study just published by the National Bureau of Economic Research. Entitled “Selling Fast and Buying Slowly: Heuristics and Business Performance of Institutional Investors,” the study’s authors are Lawrence Schmidt, an MIT professor of finance; Klakow Akepanidtawron, IMF economist; Alex Imas, assistant professor of behavioral sciences and economics at the University of Chicago; and Rick Di Mascio of Analytics.
The title of the study is a play about the book written several years ago by Nobel Prize-winning economist Daniel Kahneman entitled “Thinking Fast and Slow.” Kahneman focused on the distinction between two types of thinking: fast (which is instinctive and emotional) and slow (which is more deliberate and logical).
The authors of this new study find that there is a similar distinction between the way advisors approach their buying and selling decisions: buying is slower and deliberate and selling faster and more emotionally.
The authors came to this conclusion by analyzing a single database that contained transaction-by-transaction data from a group of institutional investors who each managed more than $ 500 million in assets. The database contained 89 million separate transactions between 2000 and 2016. The researchers found that “while investors show a clear skill in buying, their selling decisions perform substantially lower.”
Specifically, the shares added to the investors’ portfolio “exceed both the benchmark and a strategy that randomly buys more asset shares already in the portfolio by more than 100 basis points. [1.0%] annually per dollar of purchase volume. In contrast, the shares sold not only do not outperform a random sales strategy without skills, but they always outperform it in substantial quantities. “
This new study inspired me to investigate whether similar behavior is common among investment newsletters. Although I did not exactly replicate the researchers ’methodology, I built two hypothetical portfolios: one contained all the shares that were bought at any time in the 2020 calendar using any of the investment bulletins overseen by Hulbert Financial Digest; the second portfolio contained all the shares that were sold at any time this year.
The graph above shows the performance of these two portfolios this year: the portfolio of shares bought in 2020 has increased by 19.1% so far this year to August 17, compared to a gain of 19, 6% for the S&P 500 SPX,
(both portfolio returns include reinvested dividends). The difference between these two yields is not large enough to be considered statistically significant.
Last year’s sales portfolio is another story. Its year-on-year gain is 28.0%, nearly eight percentage points better than the S&P 500 and about nine percentage points ahead of the “buy” portfolio. These results are consistent with those achieved by this new study.
Know when to fold them
These results are disconcerting, as in theory the factors that determine which stocks will outperform the market are no different from those involved in determining which ones will not. That counselors are consistently better at each other suggests that various psychological and behavioral biases should work. These biases are the “heuristics” that researchers refer to in the title of their new article.
One of the biases that researchers identify is the tendency to pay much more attention to the purchase than to the decision to sell. The researchers conducted extensive interviews with various managers, who revealed that they devote disproportionate energy to finding the next box office stock, while considering the sale decision “largely as a way to raise cash for shopping “.
One consequence of this bias is that the typical advisor will be based on the general rules when selling, replacing mental shortcuts instead of undertaking the same extensive and deliberate analysis they do on the buying side. One of these rules is to sell positions held at a loss, for example, which can lead to the sale of shares that otherwise remain compelling long-term bets.
In 2020, oil and gas stocks, for example, were crushed during the early stages of pandemic-induced economic closures, prompting many advisers who had maintained those stocks to throw in the towel. In contrast, so far this year, the oil and gas sectors are leading the market upwards.
The cure for this bias is to devote as much energy to sales decisions as to purchases. One suggestion from the authors of this new study is to systematically track the stocks you sell in the same way you track your purchases. This way you can learn from your mistakes and become a better investor.
Unfortunately, this is not how we view our sales decisions. If we sell our losers, for example, each of these sales represents a failure, which we want to forget. As one institutional manager told researchers: “When I sell, I’m done. In fact, after selling, I pass and delete the name of the position of the whole universe of research ”.
Mark Hulbert regularly contributes to MarketWatch. His Hulbert Ratings keeps track of investment bulletins that pay a fixed fee to be audited. You can contact him at [email protected]
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