Commentary on Political Economy

Friday, 23 April 2021

 

How to Keep Your Cool When Markets Are Sizzling

When everyone around you seems to be getting rich quick, it’s hard to control your fear of missing out. But buying assets just because they’re hot is a good way to get burned.

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Buy low, sell high.

Is any investing advice more universal—or more universally ignored?

That market axiom was made for times like these, when stocks are hovering near all-time highs, digital currencies are heading to the moon and commodity prices are surging. Yet, when markets seem to be breaking records every day, your emotions naturally prompt you to buy high, not to sell.

Even the world’s greatest investors find selling harder than buying. Peter Lynch, former manager of the Fidelity Magellan fund, has said his “greatest mistakes” were selling at the wrong time.

That’s largely because of the unbearable feeling of FOMO, fear of missing out. Sell a winner too soon, and you have to watch from the sidelines as it continues to soar. The most you could have lost from keeping it is 100%, but the gains you can miss out on by selling too soon are unlimited.

It hurts not to buy an asset that goes on to become a huge winner. But it stings far worse to sell one. That’s an active decision, easier to imagine undoing. That focuses your attention on the mistake, making you feel you should have made a different decision and filling you with regret.

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Never are those feelings more intense than when markets are setting records and everyone around you seems to be getting rich quick.

And the less certain you feel about what an asset is worth, the more hesitant you will be about selling. Steve Abbett, an individual investor in the Washington, D.C. area, has a nice way of explaining this.

Imagine that a company was cheap at price A and overvalued at price C. Then you would know what to do: Buy at price A and sell at price C.

If only it were that simple. “The hard part of investing,” says Mr. Abbett, “is that most stocks, most of the time,” hang around what he calls “price B,” anywhere between cheap and overvalued. In that ambiguous range of price B, “it becomes tough to tell” whether or not to sell.

The range of price B varies inversely with how much you know about the company or its industry. If you know a lot, price B is a narrow zone; if you know only a little, then it is wide and fuzzy.

The higher the market goes, the more you will see and hear about stocks that are far more expensive. Even if yours is already overpriced, thinking about others can make it seem moderate by comparison—pushing it back into that gray area of price B.

New research suggests that selling isn’t just hard to think about; most of the time, many investors might not think about it at all.

In an article published this month in the journal Nature, behavioral scientists at the University of Virginia showed that when trying to improve a situation, people don’t even consider subtracting from it. Their default solution is to try adding something instead.

Leidy Klotz, a member of the research team and author of the new book “Subtract: The Untapped Science of Less,” stumbled on this behavioral quirk while playing Legos with his 3-year-old son. “We were trying to build a bridge, and it wasn’t level,” says Prof. Klotz. “I turned around to get a block to add to the shorter column, and by the time I picked it up my son had subtracted a block from the longer column. I was amazed! It had never occurred to me to level it that way, and I’m an engineer.”

The question you should always ask yourself isn’t “What should I buy?” but rather, “What should I buy or sell?” Better yet, instead of asking how you can improve your portfolio, ask how you can streamline it.

Scouring your holdings for anything you don’t have confidence in might feel strange at a time like this, but you’re likely to end up glad you did—especially if capital-gains taxes go up later. Whenever possible, consult with your accountant and sell specific share lots to minimize your tax bill.

Yes, missing out on future gains could be painful. Missing out on future losses won’t be. In the long run, adding or keeping hot assets only because they are hot, not because you think they are undervalued, is the surest way to get burned.

Write to Jason Zweig at intelligentinvestor@wsj.com

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