Freaking Out? Before You Sell, Answer These 5 Questions

Here are some key things to consider when thinking through investment decisions

Jeffrey Ptak, CFA 4 November, 2020 | 9:49AM

Panic Graffitti

When any major event happens, like say the U.S. presidential election, for instance, you might be freaking out about how the market might react when faced with that. Your thoughts naturally turn to your investments and whether it would be better to sell to try to get out of the way of what you think could be a big wipeout in stocks and bonds.

Tempting as that seems, there's data and evidence galore showing that it's a bad idea to try to time the market in this fashion. Investors usually fail at it because markets are highly efficient, employing news and other information at warp speed and making short-term price moves very hard to predict. You're better off sticking with your long-term plan, which hopefully calls for wide diversification across asset classes anyway.

But those long odds won't discourage some of you from trying anyway. With that in mind, here's a short list of questions you ought to consider before you hit the sell button. Taken together, they form a framework that might be useful for thinking through investment decisions not just at momentous times like this one but throughout your investing journey.

Question 1: What Makes Today Different?
Maybe you're feeling greater doubts about the fundamentals of what you own today than you did a week ago. For instance, you think your stock investments will see slower earnings growth or that interest rates will rise, dinging your bond holdings.

Or it could be you're feeling unease for other reasons, like fear and anxiety stemming from the election and the uncertainty you think it will usher in. If that's the case, there's no shame in it. What's important is trying to pinpoint why today is different than, say, a week ago, for it can yield insights into whether it's logic or emotion that's propelling your decision to sell. Rewinding a bit and comparing your mindset today--when you're primed to sell--with where it was not too long ago can help you unpack and clarify your thinking.

Question 2: Is That Priced In?
True, you could say you're selling not either because you expect market fundamentals to deteriorate or because you're feeling anxious and uncertain, but a little of both. Maybe you're anxious because you think company fundamentals will erode or the economy will go into a funk. Or you believe because others are likely to share your same anxiety, it will augur a broader slowdown that dents company earnings, and so forth. These sentiments are perfectly understandable, intuitive even.

The question you want to ask yourself, though, is whether they are already "priced in" the market. After all, investors in aggregate tend to do a pretty good job of factoring in different possibilities and future scenarios, and that's reflected in market prices. So, in order to profit you not only have to draw the right conclusion about the likelihood of future outcomes but also do it before the market coalesces around that view. 

Question 3: Don't Try to Time Elections
Which brings us back to our question: Is it priced in? This is a tough one to answer as the market isn't going to come right out and tell you what is or isn't factored in. It has to be inferred, and that's a tall order even for professional investors, the clear majority of whom fail to keep up with market indexes despite the time and resources they put into the effort. But it's a question you ought to tackle.

Question 4: Who Is on the Other Side?
Suppose you're able to build a case that the possibility markets will go sideways hasn't been properly priced in. The next question you'd want to ask yourself is what's the contrarian view? That is, who would be buying from me if I were to sell or reduce risk in my portfolio? You can't literally identify that party, but you can try to deduce the buyer's logic. Maybe the buyer thinks fundamentals will improve, investors will get even more bullish, or a little of both.

Whatever the case, seeing things through the eyes of the other side can help you to assess some of the counterarguments to what you're considering doing. Is there a flaw in your thinking? Are you allowing certain factors to crowd out others that are important to bear in mind?

Question 5: What Will Change My Mind?
Really, this question probably ought to be the first one you ask, as it's simple but can be pretty revealing. Here's the question: If you're going to sell now, what would make you a buyer again in the future and how would you decide when the time was right?

If you're swirling in emotion and that's your main motivation for selling, then it stands to reason you'd only be ready to buy once you felt like the coast was clear. But by then it's likely that the market has already zoomed higher and you've missed out on at least a portion of the gains. In that scenario, you risk falling into the trap of chasing the market, selling low and buying high.

But let's put that aside and assume you're considering selling based on concerns over market fundamentals. Even in that scenario it can be worthwhile to try to envision what the fundamental picture would need to look like to kindle your interest in buying again. And as you do so, you'd want to ask yourself some of the questions above. Namely, by the time you conclude that fundamentals have improved enough, has the market already priced that improvement in? What might be motivating a seller to you at that time? And after you buy, what might prompt you to sell again in the future?

 

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About Author

Jeffrey Ptak, CFA

Jeffrey Ptak, CFA  Jeffrey Ptak, CFA, is head of global manager research for Morningstar.

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