Are you trying to know when to take profits? With the stock markets at record highs, it's tough not to think this way.
The last thing we want to do is give up all our gains we’ve made during this pandemic. This article will help figure out the never-ending battle between fear and greed.
Know When To Take Profits
There are two things investors need to battle on a constant basis. The first thing is fear. We must eradicate fear when markets are collapsing because we know great fear is when fortunes are made.
I distinctly remember when the S&P 500 closed at its low of 666 on March 6, 2009. The mark of the devil was such an insult to injury on Wall Street that hardly anybody decided to buy that day.
Fear can be overcome through experience as we've seen a rebound in plenty of asset classes time and time again. We're seeing a tremendous recovery in housing right now for example. Having a cash hoard so great that you can withstand any amount of body blows is also a key element of combating fear.
But feeling secure is not the way to make money. You've got to actually get over your fear of losing your security by deploying funds that will initially lose money since nobody can time the bottom.
Greed is the other element an investor must overcome if you want to know when to take profits. The desire to make an ever increasing amount of money has ruined people's lives.
Back in the dotcom bubble of 1999-2000, I had several friends who were paper millionaires and unwilling to sell their dotcom company shares out of belief prices would only go higher. Not only did their company shares tank, they ended up owing taxes on the value when their options were exercised.
Let's say you exercise $1 million worth of options at $100 a share. You decide not to sell and the stock detonates to $10 a share. You still owe about $500,000 in taxes on the $1 million even though your shares are only worth $100,000! Another win for government.
Let me tell you another story about greed. The owner of a deli I went to for 11 years in downtown San Francisco was a jovial fella who used to make the best banana nut muffins. He margined up his $50,000 in capital to $200,000 online.
One morning after the collapse he revealed to me over coffee that his portfolio was valued at $800,000 at the peak. $800,000 was enough to move back to his home country of Iran and live like a Shah for the rest of his life.
Instead of selling everything to fulfill his dreams at the age of 32, he hung on and lost over $150,000 from his initial $50,000 investment due to margin. That's a $950,000 swing. He did not know when to take profits and it his greed cost him big.
I stopped in last month to pay a visit. 13 years after the dotcom collapse he's still making breakfast burritos and banana nut muffins for whiny customers at the age of 45.
Know When To Take Profits: Two Sides
As an economics major in undergrad with a focus on finance during business school, I've been trained to think in Yin Yang terms. When the economy is improving the stock markets tend to follow suite due to an increase in corporate profits. More people find jobs and the world is a better place again.
When I'm sitting in mega traffic thinking of bashing the Mercedes in front of me, to calm my nerves I think how wonderful it is everybody is working again so that my investments go higher.
What people forget during good times is that when there is a tighter labor supply prices go up for everything including rent, gas, food, and interest rates.
Prices go from P1 to P2 and suddenly it becomes a little too painful at the pump to commute to work 40 miles a day. Interest rates inch up making your wasteful car payments no longer affordable.
If salaries get too high companies begin to slow down hiring or even fire the now overpaid elder staff. You might even see a demand curve shift to the right due to expectation changes in incomes. The list goes on and on.
The rich are getting really rich in a bull market, while those who rent and diligently save but do not invest get poorer by the day. If you do not own real assets, you can kiss your happiness goodbye as things become unaffordable.
As the middle class slows down consumption, so begins the decline in corporate profits. Thankfully the trend is up and to the right. But let's not kid ourselves about the cycles in between.
Reconciling Predictions Can Help You Know When To Take Profits
I love to make predictions. My most recent prediction was predicting the S&P 500 would bottom out in March 2020 with my post. That was a good one that gave me the courage to buy $250,000 worth of stock. Now we're at record-highs with the S&P 500 over 4,400!
Back in 2013, my prediction state that the S&P 500 will climb 8.8% to 1,551. The post goes into detail how I came up with a 1,550 target price. At the close of March 8, the S&P 500 ended at 1,551.18 and it's now looking like my call is a little too conservative.
I had to make a decision Friday morning whether to let my investments ride or take profits. Things are obviously recovering quite handsomely and the sequester fear mongering did nothing but provide happiness to the rest of us given the government finally has to eat their own poop.
During my decision making process, I thought back to the 1997 Asian financial crisis, the 2000 dotcom meltdown, SARS/bird flu scare in 2003, and the Armageddon of 2008-2010 to remind myself of financial pain. I looked at the composition of my net worth on Personal Capital to see a full 73% of my wealth leveraged into the stock market and real estate market. Things felt good, but feeling good is almost always temporary.
Most of my equity exposure is in investments that cannot readily be sold (structured notes with 2-5 year time horizons, deferred compensation in the form of company stock, private equity etc). I like to feel in control of my finances, even though I may only be experiencing the illusion of control.
Selling real estate is an entirely different ordeal that doesn't make sense now given we're in a multi-year upcycle and transaction costs are prohibitively expensive. The only thing I can easily adjust is my 401k.
I came to the conclusion that it's time to be disciplined and sell equities. My 401k is now 80% in stable value (50%) and fixed income funds (30%), and only 20% equities. The stable value funds should return at least 1.7% risk free for the remainder of the year.
Meanwhile, I see value in 10-year treasuries above 2% over the short-term, but not over the long term. I believe the S&P 500 is fully valued today. Rising interest rates and $4+/gallon gas will slow down the pace of consumption. Meanwhile, the sequester effect will start to be felt over the next six months.
Be Happy With What You Want
If I'm wrong, then great. A rising stock market really helps those in the top 20% who own over 90% of stock market wealth. A rising stock market also helps everybody thanks to an improving labor market. Just like how nobody can pick the bottom, nobody can pick the top either. The momentum is there and we may very well keep charging to 1,600 on the S&P 500.
With my 401k rebalance, I've now freed up time to focus my efforts on making money elsewhere. There are so many rental properties to see and so many online projects to execute.
Perhaps the markets will rocket much higher, making a 8.8% prediction look completely silly. But at 1,551, I'm happy to wait. I've survived another year of not losing money and I hope the same goes for all of you.
To Recap: Know When To Take Profits
- Review your predictions for the year and see what has gone right and what has gone wrong.
- Think about the various positive and negative catalysts in the economy that may improve or derail your arguments over the next six months.
- Reassess your financial situation. Do you have stable cash flow? Do you have passive income? Are there changes on the horizon such as an upcoming expense or an impending retirement?
- Evaluate current valuations and expected earnings 12 months out. Are they reasonable?
- Look for new opportunities and laggard stocks and sectors. Everything is relative in investing.
- Remind yourself that you can never lose if you lock in a gain.
- Repeat the cycle once you've mustered up the courage to invest again.
Take Profits And Reivinest In Real Estate
I would suggest taking some profits in stocks and turning some of the funny money into real assets. Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income.
Take a look at my two favorite real estate crowdfunding platforms that are free to sign up and explore:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.
About the Author:
Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered.
In 2012, Sam was able to retire at the age of 34 largely due to his investments in real estate crowdfunding that now generate roughly $250,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
35 thoughts on “How To Know When To Take Profits? A Discussion Of Fear And Greed”
My approach is a little bit different. The basic philosophy I have is to start with stocks that I would be comfortable holding for years. I then look to sell them if circumstances change, the business isn’t what it was when I first invested. Taking profits is great, but you short change yourself by cashing out of a great investment before you have realized its potential. The investors in Coca Cola who have hung around for years have made millions. They may well have taken some money off the table along the way, but holding on has allowed them to receive more in annual dividends then what they actually invested. I realize stock values will go down at times , thats the nature of the market, but with a dividend paying stock in a quality business, you get paid to hang around and wait.
Most of my exits are with trailing stop losses. I typically tighten up the trail (%) as the stock moves up. It doesn’t (and shouldn’t) capture the top but it typically gets me out of a postion a few points ahead of a straight market sell order.
Sounds like a good plan and makes a lot of sense.
I took some profits so I’m going to lay low for a bit and see how things go. I wouldn’t be surprised to see another big correction. So I’m going to probably wait a few more months before thinking about getting back in.
I think it’s a GREAT idea to just buy Berkshire Hathaway and lock it up for 10, 20, 30, 40 years. Can’t argue with Buffett and the team, so why not just join em.
Market is being held together by renters moratorium. 10 million with extra money equal to their rent is good for companies revenue and bottom line. Looks like market will not reflect the true state of economy until the end of the year assuming moratorium is not extended again.
I sold all my investments and took the the gains. Now deciding what to do next. In the meantime, I’ll go sit in the corner . .
Maybe use your profits and treat yourself to a month off in Aruba?
I’m planning a two weeker to Mexico right now actually :)
Mexico? Where about. I take every opportunity that I get to visit a native Spanish speaking country. Email me and maybe I can meet up with you. :-)
I think the market will continue to trend higher in the coming months unless the effects of the sequester really hit the economy hard. That being said, I’m a little uneasy about all the good feelings and positive vibes towards the market lately. My plan is to be very cautious with my new money and I’ll probably end up keeping most of it on the sidelines or in different types of investments for the foreseeable future.
Thanks for keeping me grounded. You are a trained economist and doesn’t have any ulterior motive for your recommendations. That’s why I listen to you. I took some profit last week and I need to do more very soon. Our allocation is still a little heavy on the equity side.
I’ll be happy with 8% for the year. I think we’ll see a downturn this year and I’ll get back in then.
I think it is essential to make sure that you do the research beforehand. Things have been known to change on a dime, so careful analysis might prevent some headaches when those things do actually change. It’s just something my family has taught me about investing.
Good post Sam! That greed really can be tricky to watch and I have seen way too many people in my day lose everything because they were greedy. I don’t know where the market is going, though I like where it is and what it has done to my portfolio this year. I am doing my best to stay the course and not listen to the talking heads on TV but stick to my investment plan.
John, I’d love to hear what your investment plan is.
There’s another reason your 2013 prediction was right on, and may still be conservative: the crashes in the past came “at the right time” i.e. after that particular economic cycle had run its course. If you go back almost a century, you can see we get a recession every 7-10 years, almost like clockwork. (https://bit.ly/economy_chart if you want to see a chart proving that.)
The 2008 meltdown came 7 years after the 01-02 tech bubble popping. We’re not even 4 years past the last economic cycle bottom, and earnings have barely recovered on publicly traded stocks. We’ve not even hit our stride in the “normal” stock market recovery. What we’re seeing is a new bubble forming, fueled by all that Quantitative Easing which has nowhere else to go. But, even with that the PE on the S&P 500 is nowhere near scary territory yet.
Therefore, I think we still have at least two more years of appreciation left before we even approach the window of the normal economic cycle turndown. But what do I know? :)
My prediction is definitely looking conservative now, however, too bad we can’t know then what we know now! At the start of the year there were plenty of dire predictions or flat market predictions.
Confirmation bias is alive and well. However, I do see a return to housing mania which will play out all year. People are feeling quite confident.
I think you have to keep a close eye on Europe. Over the last couple of years, when news out of Europe comes, it tends to come in a pretty quick wave and that will in turn spook the market. So far it’s been relatively quiet.
The last couple of years have also paid well for those who sold in May, following the old axiom, sell in May and go away. Last years results didn’t yield for those who stayed out too long, but if you can protect yourself from a decline before another rise, that’s always something to consider.
It’s impressive how sanguine everybody is about Europe now.
When I took a business trip there last year to study the happiest people on Earth, the conclusion was they were indeed happy and hence BUY. The media was blowing things out of proportion. Now that the media has cried wolf, they are jumping on the bandwagon now. Nice.
It is always hurts to take your gains too quickly. However, it hurts a lot worse to lose them, IMO. Well done. Also, I love that you included that the rich get really rich during a bull market. I think people often forget this particular nugget: “If I’m wrong, then great. A rising stock market really helps those in the top 20% who own over 90% of stock market wealth.”
It definitely is disappointing to sell too soon. I’ve done this many times before and I expect to do so many times again. I really try and stick to my investment targets and sell and buy when targets are reached. Round tripping investments is the worst and I’ve got a lot that is locked up.
I just recently used a trailing stop order for the first time in one of my portfolios. it was somewhat interesting to see it play out. Originally had it selling all the shares of a company I was holding, but I switched it to just under 1/2 of the shares to be sold in the trailing stop loss order.
It hit because there was enough of a dip after it climbed. So effectively I locked in a 1.7% gain that happened in 2 1/2 weeks. I’m still holding onto the other shares and they’re up 5%. I now know that I’ll use a simple stop loss order as opposed to the trailing stop loss order.
I hope the market goes up another 8-10%!
I like how in depth you’re thinking about this. However, I think you’re trying to outsmart the market here. Why not just buy and hold for the long term rather then thinking about your returns year to year?
I can understand if your risk ratio is out of balance, i.e., your equities comprise 70% of your portfolio when your diversification profile says you should only be 60% into stocks. Then I would understand selling shares to purchase more fixed income products (bonds, Lending Club, etc.).
But I don’t really see you making that argument in your post. I see a lot of emotion and fear that the market is overpriced and will decline, so you want to get out while the gettings good. Again, I think that’s an emotional response and not approaching the issue logically.
I don’t know where the market is going to go this year. Or next year. Or any year. I don’t really care. I know that a buy and hold strategy, while rebalancing maybe once a year to fit a risk profile (75% stocks, 25% fixed income for example), historically has returned 6-7% after inflation for the last 140 years. Do I think the next 140 years are going to be crazier than the last 140 years, with all the depressions, recessions, wars, booms, busts, and technological progress? Maybe, maybe not. I’m confident we’ll get through it just like our fathers, grandfathers, and great-grandfathers did.
What I do know is that actively trading and trying to time the market is a great way to put money into the stockbroker’s pocket and to miss out on excellent opportunities for wealth creation.
A long response, but I know that for myself, I’m not cashing out. Good luck to you whatever decision you make!
You’re probably right, which is why you’ve built up a solid net worth of $10,000 with a plan to triple it by year’s end vs me just struggling to grow my net worth by 10% a year or so. You’ve got the cash flow to withstand the hits. I just want to have enough to pay the bills hence the fear.
I come for the photos, but stay for the wisdom. Very sensible and clear post, once again FS.
This is the part where I offer my words, but at this point with my track record, all I know is my next words are going to be “famous last word”:-)
Just reading this post made me nervous, given how often I’ve boned this up through the years!
If the S&P 500 rises to 1600 this year, what will you do in January? Try to get some of next year’s return, or stay out until it goes under 1500?
Good question. I’ll have to revisit my risk exposure again as I’m doing now. If we get to 1,600 this year, I may even be tempted to go back to work as the economy will be rocking and pay in the finance industry will also follow suit.
Given my real estate holdings, this is the asset class where the real juice happens due to leverage. Stocks are very low octane in a bull market compared to real estate.
Cool, I hope we all get a chance to increase our capital this year and next year! If you’re extremely confident you can apply leverage to the stocks too :)
Why not? You can never lose investing in the stock markets! Lol
I would be curious of what you consider a “stable value fund”?
They are ones that don’t lose value given the composition of various cash funds and low risk bond funds.
Fidelity MIP III Fund is one such example and a Fixed Interest Fund by Mass mutual is another. Think of it like a money market plus fund.
I think this is a good reminder even if you choose to ignore the advice! Everyone is different and invests for different reasons. I invest for growth and picked segments as well as diversified indices to take out some of the volatility. I try to focus very long (30-35 years) term. I may feel different in retirement, but I am not dependent on my portfolio to support me in retirement.
I prefer to establish a priori guidelines for buying and selling that fit in with my overall investment strategy. Because dividend growth investing is a buy and hold game, my rules are based on fundamental changes to the company or the dividend stream rather than short term changes to the stock price. My portfolio value may go up and down like a roller coaster, but so long as my holdings continue to make money and distribute that money to me, I’m fine with being patient.
it is hard not to regret an exit that was too quick. generally put a stop loss instead of cashing out, but since it is always a pivot level the price tends to come back to my stop loss before reaching higher. If it shoots straight up, I move the stop loss gradually.