Buy Low & Sell High - Is Investing Really That Easy?

It seems like every book you read about investing contains the tip to “buy low and sell high.” When you think about it, this sounds like great advice. Buy a stock when it is cheap, and then sell it when it becomes more expensive. That’s basically like saying you should buy a used car for cheap, and then resell it for a higher price. It sounds great in theory, but how do you actually do this? Let’s first discuss some of the issues with the concept of “buy low and sell high.”

We don’t know when stocks are low

Do you know which company’s stock is primed to go up in value? Better yet, do you know this information and also believe no one else knows? I only ask because if other people know what you know, they would already be buying the stock which would drive up the price, effectively making your knowledge worthless! Research has shown time and time again that stock markets are efficient, which means no one actually knows if a company’s stock is going to go up or down tomorrow.

Psychology of selling high and buying low

When someone says “sell high” they are saying you have to sell your winners. After a stock has performed really well, you then have to sell it. Why would you want to sell your winning stocks? You sell your winners because they have done well, and you want to lock in your gain. Logically it makes sense, but emotionally it isn’t easy. Humans tend to experience recency effect, in which we believe if a stock has performed well recently, it will continue to do so.

Buying low is just as difficult as selling high. If a stock you own has lost half its value, why would you want to buy more? Relativity speaking, your stock has just become cheaper and now may be the best time to buy. If you bought the stock at $100 and now it is worth $25, it is $75 cheaper than it was just a little while ago. If you were willing to buy at $100, buying at $25 should seem like a steal!

“Wait, you’re telling me there’s no way to buy low and sell high?”

No! That is not what I’m telling you, I just want to be sure you understand the difficulty of such a strategy. The best thing you can do to overcome these difficulties is to automate, or at least systematize, the process of buying low and selling high – it is called rebalancing.

Let’s say you want 50% of your portfolio in stocks and 50% in bonds. Over time, your stocks go up and your bonds go down, so you now have 60% in stocks and 40% in bonds. Rebalancing is the act of selling some of your stocks, and buying more bonds, to have 50% in each again. Sounds simple right? Not so fast… When investors actually go to sell those stocks, the psychology we just discussed kicks in. “But my stocks have done so well, I don’t want to sell them!” “Bonds are doing pitiful, why would I buy more?” Research studies suggest you can get as much as 1% higher return in the long-term by rebalancing frequently. That being said, it is still really hard to do.

The best thing you can do is automate the process by deciding that on a certain date, you will rebalance no matter what. Research has suggested there are benefits to rebalancing at least annually. Pick a date that you will remember (like your birthday) and put it on your calendar to sell some of the winners in your portfolio and buy some of the losers. It isn’t easy, but it is something investors need to do.

So what do you think? Do you have a structured time to sell your winners and buy more of your losers? Have you ever tried to do this, but not been able to because you something was stopping you? Please share your thoughts in the comments section!

Just for reference, we do a rebalance check for our clients each week, but only buy or sell if an asset class is more than 20% different than the client’s goal. So if we are targeting 10% in US stocks, we buy more if they go below 8% or sell if they go above 12%.

Alan Moore is a fee-only financial planner and founder of Serenity Financial Consulting in Shorewood WI. Follow him on Twitter @R_Alan_Moore. You can contact him at alan@serenityfc.com, 414-455-5313, or visit his website at www.SerenityFC.com. Want more education? Download your free guide to the “10 Easy Steps To Securing Your Financial Future Today.”