Do Investors Need To Bank Gains On Highly Appreciated Positions?

etfsDavid Fabian:  An interesting strategy that I often hear from investors is the notion of banking gains on highly appreciated positions. Some are simply trying to time the market by buying low and selling high. I can understand that philosophy to some degree, as we all want to shape our entry and exit points at opportunistic levels. This type of investing is usually most appropriate for short to intermediate-term traders that have the time, tools, and discipline to make changes on a more frequent basis.

Far more concerning is the group of long-term investors that may not know why they are selling their stocks or bonds to begin with. This latter crowd may think that by selling a core holding, they are now converting an unrealized gain to a realized gain. It creates a euphoric sensation and boost of confidence that you “banked a winner”. However, that elated feeling may be quickly dispelled when you have to answer some of the following questions:

  1. Did I sell that holding because it was underperforming, had high fees, or was it just simply that I woke up this morning and needed something to do?
  2. How does this impact my asset allocation or correlation with the market?
  3. What do I do now that I have excess cash on hand?
  4. When do I put this money back to work in the market?
  5. What are the tax implications of selling this holding?
  6. How much did this transaction generate in fees?

A year like 2015, where stocks and bonds jostled in a wide range but made little forward progress, can be frustrating for most investors. It begins to eat at your psyche that you need to shake things up in order to forcefully create gains rather than sticking with an investment strategy that works for your goals and risk tolerance.

Making a big change to your asset allocation may also dislocate you from the market at an inopportune time. If you sell a significant portion of your stocks and sit in cash while the market rallies 10%, then you are already behind the eight ball and feeling pressure to play chase. This could potentially lead to greater frustration and poor decision making.

Of course, there is always the chance that you sell and the market falls 10% as well. Then you are only left with the decision of when to get back in. It sounds easy, but we all know that when the market drops 10%, it always looks like it’s going to go down ANOTHER 10%. This makes us gun-shy to put money back to work for fear of further losses or trying to overthink the situation and pick a perfect bottom.

In my opinion, every change to your long-term portfolio should be made with calculated steps that ensure you are making forward progress. For example, in my Opportunistic Growth portfolio, I recently made a change by selling a tactical position in the PowerShares Buyback Achievers Portfolio (NYSEARCA:PKW) and purchasing the iShares MSCI USA Quality ETF (NYSEARCA:QUAL) instead.

My thesis for this shakeup was two-fold:

  1. Despite owning PKW for several years in the model portfolio, it has recent begun to underperform and no longer fit with the current market climate. I assessed its attributes versus other opportunities and found a suitable alternative that I believe would add greater value.
  2. QUAL offered lower embedded expenses, a diversified portfolio of stocks with strong fundamental characteristics, and a solid track record to-date. This fit with the qualities I was searching for and also ties in with my other core holdings in a cohesive manner.

After I identified the pros and cons of this switch, I decisively made the transaction from one fund to the other in an almost seamless transition.

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