The trouble with taking a balanced approach to investing in shares is that it's a bit like having one foot in boiling water and the other in ice: getting the right mix can involve a lot of pain.
Historically, investors are a lot less confident about locking-in their profits by selling down stocks than buying them.
During the recent share market selloff, courtesy of the global panic around the Trump-Tariff disruption, local investors can be forgiven for impulsively wanting to run for the exit.
Since hitting a high of 8,555 points in mid-February, the ASX200 is down around 7% at 7962 points.
However, conventional wisdom suggests it’s better to stay invested in the market when the going gets tough. Wayne Leggett of Paramount Financial Solutions reminds investors that by jumping out, they risk being on the sidelines at the very moment when markets pick up. When they do move up, the gains tend to be sharp.
There’s no lack of historical data to confirm convincingly that share markets can and do bounce after a correction, and when they do, they typically exceed previous highs.
30-year performance
Let’s look at the average annual returns for six major asset classes over the last 30 years.
The 2024 Vanguard Index Chart covering the period from 1 July 1994 to 30 June 2024 shows how a starting balance of $10,000 would have changed in value after being invested in each asset class.
US shares
With an average total annual return of 11.1%, a $10,000 investment in the top 500 U.S. companies at 1 July 1994, when measured by the S&P 500 Total Return Index (in Australian dollars), would have grown to $237,318 by 30 June 2024. That’s a total compound return of more than 2,270% without an investor making any additional investments beyond the initial $10,000 in 1994, other than by reinvesting all the income distributions that they received over time.
Australian shares
A $10,000 investment in the Australian share market over the same time period, when measured by the S&P/ASX All Ordinaries Total Return Index, would have increased to $135,165 based on the same strategy of reinvesting all income distributions. That represents a 9.1% per annum average annual return over the 30-year period, and a total compound return of more than 1,250%.
International shares
Investing in international shares (when measured by the MSCI World ex-Australia Net Total Return Index – in Australian dollars), $10,000 would have risen to $105,082 based on the 8.2% average annual return over the period. This represents a total compound return of about 950%.
Australian listed property
In Australian listed property securities, when measured by the S&P/ASX 200 A-REIT Total Return Index, a $10,000 investment would have grown to $94,587. This represents an average annual return of 7.8% and a total compound return of almost 846%.
Australian bonds
Australian bonds, when measured by the Bloomberg AusBond Composite 0+ Yr Index, would have delivered an average annual return of 5.6%, increasing a $10,000 investment fivefold to $51,797. This represents a total compound return of around 418%.
Cash
The lowest long-term return over three decades has been from cash. When measured by the Bloomberg AusBond Bank Bill Index, it would have earned just 4.2% per annum and grown to $34,552. This is over $200,000 less than an investment in the broad U.S. share market and about $100,000 less than an investment in the broad Australian share market.
Even still, the total compound return on cash would have been almost 246% based on a $10,000 initial investment.
Key trigger selling points
One of the benefits of having at least a couple of years' living expenses in cash is that when markets tank, retirees aren’t forced to divest stocks at any price to generate cash while waiting for markets to recover.
However, by identifying key trigger-points to prompt a timely portfolio review, Azzet has provided you with some guiding principles for selling down a stock.
Let's look at the key reasons why you might consider selling a stock down within your portfolio.
Price eclipses value
One of the cornerstones of Value Investing championed by leading investor Warren Buffet is the knowledge that a company’s share price cannot run ahead of its underlying performance forever. In other words, the share price and the company’s intrinsic value - its perceived true value - are destined to eventually converge.
The closer a company’s share price gets to its intrinsic value, the greater the risk of holding stock. And the more the share price exceeds a company’s intrinsic value, the greater the argument for selling down.
Below are some examples of when share price rises well above value warrants a sell down.
For example, having run up 58% in the last year, Computershare (ASX: CPU) is now regarded by Morningstar as Sell at $40.37 a share.
Likewise, with Commonwealth Bank of Australia (ASX: CBA) trading ahead of [Morningstar’s] fair value of around $126.36, the consensus is Moderate Sell.
While there’s no shortage of stocks that look over-priced, your job is to monitor closely when it might be time to lock-in gains. Whether you exit completely depends on your outlook for the stock, and any future upside to current valuations.
Cut and run
The same can be said when share price and value are seriously uncorrelated.
Setting aside chronic poor performers, it’s not always immediately clear why you should sell a stock. This is especially true if the company is a former share market darling, like Domino’s Pizza Enterprises (ASX: DMP), or has attracted investors due to its sheer size, so here are some helpful tips.
Remember, stocks that are significantly underpriced typically become that way for good reasons: bad management, business performance, loss of competitive edge.
These factors result in declining intrinsic valuations and less promising growth prospects. In the long run return on equity and (ROE) falls, along with cash flow.
The trick is to take these smouldering time-bombs out of your portfolio before they do additional damage and use the funds to buy superior investment opportunities elsewhere.
Two examples include auto repair chain AMA Group (ASX: AMA) and payments company EML Payments (ASX: EML), both of which have shed the bulk of their shareholder value in recent years.
When trying to find value traps like these, look for companies trading at a discount, but whose future valuations are forecast to decline further.
This article does not constitute financial product advice. You should consider independent advice before making financial decisions.
