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When Does It Make Sense to Take Profits From Your Biggest Winners?

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Through a combination of good timing, luck and a raging bull market, a number of investors are sitting on massive gains from investments made during the Corona crash last spring.

Many of 2020’s biggest gainers have experienced further gains in 2021 while others have come back down to earth a bit. This is a good problem to have but it’s the type of decision that can play head games with you.

Should I lock in gains now? Double down and buy more? Close my eyes and hold on?

In this piece at Fortune I looked at some questions to ask yourself when thinking through this decision.

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From the bottom last March, the S&P 500 went on to have its biggest price gains since 1950, rising nearly 75%.

Those gains seem paltry by comparison when looking at a number of individual stocks or cryptocurrencies.

Since the market bottomed on March 23, 2020, Tesla is up nearly 750%. Wayfair has risen more than 900%. Penn National Gaming has soared 820%. Bitcoin is up 650%, while Ethereum has surged more than 1,000%.

These are extraordinary long-term gains for any investor, but the fact that they have occurred in such a short period of time makes it difficult for investors to figure out what to do next.

Do you take profits off the table? Let your winnings rise in hopes of even greater gains in the future? Try to pick the next big winner?

Unfortunately, there are no easy answers, because the future is unknowable. Obviously, sitting on huge gains is a good problem to have as an investor, but it can be a problem nonetheless if you don’t have a plan in place to guide your actions.

In lieu of a crystal ball, here are five questions investors can ask themselves to figure out what to do next after seeing enormous profits in a single holding.

Why did I buy it in the first place?

This is a question you should ask yourself before buying anything as an investor because it helps define your risk profile and time horizon. However, you’re in a much better place to consider this question from the position of big gains than big losses.

Some investors prefer to buy and hold come hell or high water. Others prefer to be more tactical in terms of taking profits or selling their losers.

Many crypto advocates have decided to buy and hold for more or less forever. Tesla has a similarly strong shareholder base. There’s nothing wrong with this strategy as long as you’re willing to put up with bone-crushing volatility on occasion.

Others don’t have the intestinal fortitude to hold on for all of eternity. If that’s the case, you need to have some sort of exit strategy or at least some rules of thumb to guide your actions and help understand when to sell all or some of your shares.

Do I have a better use for this money?

CNBC’s Jim Cramer recently announced he paid off his mortgage with profits earned from investing in Bitcoin. Is it possible Cramer will be missing out on further crypto profits in the future? Yes, that’s certainly possible.

But I don’t think anyone has ever regretted paying off their mortgage before, regardless of the opportunity cost involved. Some people have a higher risk threshold when it comes to taking on debt. Others can’t stand to pay interest and owe someone else money.

If you have another financial goal that those profits can help you meet, there’s nothing wrong with selling your winners to decrease financial stress in another area of your life.

Are there better investment opportunities available?

One of the simplest ways to keep yourself honest as an investor is to consider how you would invest your capital if all of your money was sitting in cash today and you had to start all over.

Would you still invest in the same asset classes, funds, or companies you own now? What would you do differently? What would remain unchanged?

There are tax consequences to your actions if held in a taxable account so you can’t actually do this every day in a cost-effective manner, but the idea here is to challenge your own investing ideas to ensure you’re looking at your portfolio with a fresh pair of eyes.

What does my investment plan say?

There’s a huge difference between a portfolio and a plan. A portfolio of stocks, mutual funds, ETFs, or any other investment is simply what you bought. Portfolio management is what comes next, and that requires an investment plan to guide your actions.

Portfolio management requires discipline and the foresight to plan your decisions well in advance, regardless of which way the markets go. If you’re simply buying stuff you hope will go up in price with no sell discipline or rebalancing rules, eventually you will get caught holding the bag. No one is good enough to buy only investments that go up in a straight line.

One alternative to selling everything is instituting a rules-based rebalancing plan. Let’s say you bought Tesla last March with 2% of your portfolio. After a 7x return, that position now makes up close to 15% of your portfolio. You could put a ceiling on this position.

For example, every time it gets to 10% or more of your portfolio you trim the position by selling some Tesla and buying other pieces of your portfolio that aren’t performing as strongly. It’s also worth noting Tesla shares fell more than 60% before their meteoric rise, so you could also place a floor on the position that forces you to buy anytime it falls to less than 5% of your portfolio.

You have to figure out position sizing based on what you’re comfortable with, but this is one way to systematically buy lower and sell higher over time. This can be especially beneficial to more volatile investments because you’ll have more opportunities to buy lower.

What would bring me the most regret?

Investing itself is a form of regret minimization. You’re forgoing consumption now to give yourself the opportunity to consume something else, hopefully with more money, in the future.

Some investors are better than others at holding on for dear life during a crash. Others are better suited for a risk management strategy that reduces volatility, even if that reduction in risk comes in the form of lower expected returns over the long haul.

Whatever your disposition, it can pay to figure out what you would regret more after sitting on big gains in your portfolio: (1) Missing out on further gains if you sell too early, or (2) Seeing those gains evaporate if you hold on too long.

The key to regret minimization comes from understanding yourself as an investor and which emotions will weigh on you the most.

This piece was originally published at Fortune.

 

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