After a rough day for the markets like Thursday, many investors might wonder when it’s time to let go of their exchange traded funds (ETFs).
Breaking up is hard to do, as the old song so wisely proclaimed, and it’s no less true when it comes to investing. In fact, it might even be harder. Jason Zweig for the Wall Street Journal says that using a death grip isn’t necessary.
But why do so many people do it? Both individual investors and professionals struggle with it. One Berkeley finance professor found that investors are at least 50% more likely to sell their winners than their losers. Fewer than 30% of those base their sell decisions on “extensive research,” instead selling by the seat of their pants.
Zweig points out that we’re prisoners of the past. It can be so hard to let go of something that once delivered returns in the double digits, or even something that you had such high hopes for but never really panned out. Buying is a cinch – it’s selling where it gets to be a challenge.
Just look at commodities and emerging markets – both areas are coming off fantastic runs this year, but in recent months, there have been sharp corrections. Some of the best-performing funds are now 30% or more off their highs, yet they still hold billions in assets. It makes us wonder what’s going on?
Take a look at these examples:
- iShares MSCI Emerging Markets Index (EEM): It’s 33.6% off its high of Oct. 29, 2007. It has $20.3 billion in assets.
- United States Natural Gas (UNG): It’s 46.5% off its high of July 1, 2008. It has $1.1 billion in assets.
- iShares MSCI Brazil (EWZ): It’s 34.5% off its high of May 15, 2008. It has $7.2 billion in assets.
Why are so many investors allowing themselves to get slaughtered by holding on to poor performing ETFs? If you had a plan and stuck with it, you got out of these funds in time and protected yourself plenty on the downside. Our own strategy is to get out when a fund drops 8% off its high or drops below its 200-day moving average.
Once you’re out, that money can be considered a “free agent.” You don’t have to get back in to the area you’ve just left – look around. There are always areas that are moving. Or, if you’d rather, you can sit back and wait it out.
The best and easiest way to protect yourself is by setting stop losses. Just ask yourself what’s worse: getting in to a fund, riding it to 60% returns, then watching it lose 40% of that; or getting in, riding it to the same returns, and getting out when it drops 8%?
This is what we do for our clients, and it works. Setting stop losses is the best way to protect yourself on the downside. Having both an entry and exit plan is just as important as the decision one makes as to where to put his or her money.
We realize it’s easier said than done, but sticking to the plan is rewarding when you get into the habit.