Howard Marks: Why holding onto stocks is so hard (but so essential)
If our recent Outlook Series told us anything, it’s that 2022 will be a year of unknowns. As a group, our fund managers were split between bullish or bearish with one expert, Chad Padowitz, choosing bearish for the US market, and bullish for Europe, Japan and parts of Asia.
This is a good springboard into the latest memo from Howard Marks of Oaktree Capital, which tackles the timing challenge in a “buy low, sell high” strategy.
As Marks points out, “buy low, sell high” is a misleading adage that bastardises the investment process, thanks in no small part to the luxury of hindsight.
“It’s a hackneyed caricature of the way most people view investing. But few things that are important can be distilled into just four words; thus, “buy low, sell high” is nothing but a starting point for discussion of a very complex process.”
Most investing discourse, it seems, focuses on the buying and selling of investments. Less focus is generally placed on the decision-making between those two actions. We think of capital return as being a function of buying and selling. While that’s partly true, it’s analogous to reading only the first and last chapters of a novel.
It’s that time between buying and selling when the return is generated, so it follows that an equal amount of attention should be given to the decision to hold.
Maybe the strategy could be more aptly named: “buy low, hold, hold, then sell.”
Easier said than done
In few pursuits is patience as much of a virtue as it is in investing.
“When you find an investment with the potential to compound over a long period, one of the hardest things is to be patient and maintain your position as long as doing so is warranted based on the prospective return and risk.”
It doesn’t help that investors are a skittish bunch who like to amplify the daily market and economics news more than it probably ought to be.
Marks reckons most investors trade too often as a result.
“Patient investors are able to ignore short-term performance, hold for the long run, and avoid excessive trading costs, while everyone else worries about what’s going to happen in the next month or quarter and therefore trades excessively. In addition, long-term investors can take advantage if illiquid assets become available for purchase at bargain prices.”
So why do investors sell at inopportune times? Marks provides two explanations.
Jumping the gun
The first reason investors sell prematurely is because an asset's gone up in value.
The action of selling an asset after it has gone up, known as “profit gain”, makes sense in isolation.
“A good deal of selling takes place because people like the fact that their assets show gains, and they’re afraid the profits will go away.”
But investors don’t live in a vacuum; there’s always the potential for further gains so long as a stock or other security still exists.
“When you find an investment with the potential to compound over a long period, one of the hardest things is to be patient and maintain your position as long as doing so is warranted based on the prospective return and risk,” says Marks.
“When you look at the chart for something that’s gone up and to the right for 20 years, think about all the times a holder would have had to convince himself not to sell.”
Marks points to Amazon as a prime example of a stock that has doubtless lured many an investor into realising gains at the expense of subsequent return.
“Everyone wishes they’d bought Amazon at $5 on the first day of 1998, since it’s now up 660x at $3,304.
“… But who would have continued to hold when the stock hit $85 in 1999 – up 17x in less than two years? Who among those who held on would have been able to avoid panicking in 2001, as the price fell 93%, to $6? And who wouldn’t have sold by late 2015 when it hit $600 – up 100x from the 2001 low? Yet anyone who sold at $600 captured only the first 18% of the overall rise from that low.”
By selling, investors think they are booking and thus protecting their capital gains. They are. But, as the Amazon example shows, they’re also foregoing enormous potential future returns.
“… holding is easier said than done. Too many people equate activity with adding value.”
On the flip side, investors often sell too early in the hope of minimising losses.
“Just like those who are afraid of surrendering gains, many investors worry about letting losses compound. They might fear their clients will say (or they’ll say to themselves), “What kind of a lame-brain continues to hold a security after it’s gone from $100 to $50? Everyone knows a decline like that can foreshadow further declines. And look – it happened.””
So, when should you sell?
It’s all well and good to say you should avoid selling too soon but, with the exception of income investing, assets will need to be sold at some point in order to realise a return.
“There certainly are good reasons for selling, but they have nothing to do with the fear of making mistakes, experiencing regret and looking bad,” says Marks.
“Rather, these reasons should be based on the outlook for the investment – not the psyche of the investor – and they have to be identified through hardheaded financial analysis, rigor and discipline.”
The most important thing, above all else, is to simply stay invested and take advantage of compound interest - Einstein's eighth wonder of the world.
“Most actively managed portfolios won’t outperform the market as a result of manipulation of portfolio weightings or buying and selling for purposes of market timing. You can try to add to returns by engaging in such machinations, but these actions are unlikely to work at best and can get in the way at worst.”
Timing the market, in Marks’ view, is a mugs game not worth playing.
“There are very few occasions to do so profitably and very few people who possess the skill needed to take advantage of these opportunities.”
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