No One Ever Went Broke Taking a Profit
Published on - October 8th, 2006 (Modified on - May 24th, 2007) (by J.D. Roth) If you are interested, and can afford it, you might consider setting aside some personal “investment fun money”. This is money with which you allow yourself to invest outside the standard “buy-and-hold index funds” method. If nothing else, it’s an interesting psychological experiment. It certainly teaches you how willing you are to hang onto losses, and how afraid you are of losing gains.
I already have a fine retirement account through my employer. I also plan to fully fund a Roth IRA when I’ve finished paying off my home equity loan (in March 2008). But because I have a strong itch to invest, in January of this year I opened a Roth IRA with Sharebuilder with the intention of funding it at $100 each month. During the first nine months of this year, I’ve put $700 into it.
First, I purchased $400 worth of a very beat-up General Motors. (I got in at about $20/share). I sold it a few months later for $463.25 (after all fees). I then bought $750 of Microsoft (at just over $23/share), which had just taken a plunge. I sold this stock at the end of September for $866.04 (after all fees).
Not bad, huh? I’ve turned $700 into $866.04 in just nine months. Warren Buffet would be proud. Except for a couple of things:
- Past performance is no guarantee of future results.
- My method — and I do have one — is a variation of Phil Town’s Rule #1 method. I follow the same ideas, but I do very little research. Doing “very little research” is a good way to get burned.
- I’ve spent about $44 to buy and sell these stocks. (Meaning my investments are actually worth about $910.00 if no fees were involved, and even more impressive return.) My automatic purchases have only cost $4 — which is the reason I use Sharebuilder — but each sale has cost me $18. (Sharebuilder is designed to encourage automatic buy-and-hold investments.)
- If I had left my $400 GM investment untouched, it would be worth $673.50 right now. If I had then only invested $300 in MSFT, that would be worth $352.23. In other words, it’s nice that I have $866.04, but my $700 investment would be worth $1025.73 right now if I had just bought and held. That’s 50% in nine months, which is twice as good as 25% in nine months.
I read recently that “no one ever went broke taking a profit”. Maybe so. But I’d be a little less broke if I had practiced simple “buy and hold” techniques. Still, I made my decisions based on my personal investment rules, so I can’t beat myself up over opportunity cost. Especially since I have a nice return on my money.
Now I’m sitting on my $866.04, waiting to find another stock that meets my requirements. If only UPS would drop below 70 again…
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You need to factor in also the tax due on your capital gains — selling within a year makes you liable at the short-term capital gain rate.
(Another good reason to buy and hold.)
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James is correct. I completely forgot about taxes. My return will be even less!
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hey who knows. if you stuck w/ the GM stock any longer, it might have taken another beating what with Kirk Kerkorian reconsidering his 10% stake in GM due to the break down in talks w/ Renault and Nissan.
you can always try the many other discount online brokers for these type of investment account, cutting out sharebuilder’s wacky $18 “real time” trade fee will save oodles.
e.g., same trades at trade king will save you $24. that’s a movie night out w/ dinner! woot!
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“no one ever went broke taking a profit”
I think this is one of the most dangerous trading truisms. While it is true that you do not lose money on a trade where you take a profit, this approach makes it much more likely (inevitable?) that you will lose overall.
Acting on this maxim means you limit your profits. You simply cannot make a large profit, which you need to counteract your inevitable (hopefully small) losses. Even the best trading systems score 40% – 55% winners.
A better maxim is “cut your losses and let your profits run”. Now … if I could just stick to it …
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Actually, taxes are irrelevant, since all this trading took place in a Roth IRA account.
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*doh*
My mistake. Must read more closely next time.
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I agree – I would not recommend Sharebuilder for short term trading. Sharebuilder is a great product for long term investing (hard to beat $4 buy fee, free DRIP), but you can save more money if you frequently sell elsewhere.
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The problem with comparing your gains you took vs the gains you could have had is that you are looking at the prices after they have happened, which skews things.
If you had bought and held AOL from The early 90′s until now, you would have seen your $120 stock drop to $15. If you had bought and held Kmart from the early 90′s til now you would have watched your stock disappear at $0 when Kmart declared bankruptcy and restructured.
There are millions of ‘should have held’ stories that can be told after the fact. Instead of looking at what could have been, look at the fact that you doubled the market average in less than a year.
Buy and Hold is great if you pick a company that always moves forward, but there are very few of those compared to how many crash and burn.
If you could make just 2% gains a month, getting you a little over 24% gains a year (once you compound), even after taxes it’s still a better return than the market average of 11% or the dividend stock average of 14%.
The key, to me at least, is to protect your capital and let your profits run. If you can do that, you’ll come out way ahead.
You could also avoid the tax issue almost all together if you just sold your profit and kept your initial investment in the stock and then used that cash on dips of the same stock.
Interesting post, thanks for making it.
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How did you decide which stocks to try out? I usually find it bad practice to choose stocks based on their popularity (of which GM and MS are both examples).
Catch a Gideon
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actually a better idea is to cut your losses early and let your winner ride.
You implement a trailing stop loss to prevent profits turning into losses.
also trading in and out of stocks is very tax inefficient. if you want the thrill of trading, use synthetic stock positions (which I discussed recently on my blog).
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“If only UPS would drop below 70 again…”
Here’s your chance: http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=UPS&sid=0&o_symb=UPS
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