The theme of a recent blog centred on the philosophy of contra-intuity; the reality that much of which is commonly accepted as correct and logical, is often neither.
Many investors who write and speak about how to make money state that it’s never wrong to take a profit, this has been asserted so often that it has become a mantra, but is it actually true?
Like most dogmatic thinking the basic premise is a fair one; that if investments are sold at a profit then this is by definition a successful outcome.
The problem with this comes however, as they say, with the devil in the detail.
Proper investing is not gambling; it is the practice of identifying and purchasing assets with prices below intrinsic value which provides an Investor with a profit when true value reasserts.
Gambling is the practice of placing bets on uncertain outcomes in the hope (but mainly not in the certainty) of having guessed correctly.
So an investor will buy an asset knowing roughly what they believe the correct value to be, and therefore knowing they are paying less than it is worth. When the price rises to meet correct value the investor will, all things being equal, sell at a profit.
A gambler however, does not know the correct value of an asset as this was not part of his rationale for buying so it is much more difficult to decide when to sell, hence possibly the adoption of the above mantra as a catch all solution.
If we look deeper into the economics of taking a 10% profit on a purchased stock:
Assuming £10000 was originally invested gross after expenses, the charge to buy the stock will be
Broker fee circa £50
Stamp Duty £50
Charge to sell
Broker fee £55
Capital gains tax £300
TOTAL COSTS £455
So on a 10% gross gain £1,000, 45.5% is lost in fees
As the funds will be reinvested this will cost another £107 so bringing the total expenses to around 60%.
Making the Net Profit around 4%
So whilst taking 100% of the financial risk an investor gets back only 40% of the profit.
Trading in shares is cumulatively very expensive, in the above example nearly two thirds of the profits are eaten up in fees.
The risk / return reward net of costs is nothing like as appealing as the headline 10% initially sounds.
A major aspect of successful investing therefore has to be on an understanding that you:
1. are an investor not a gambler
2. buy and hold investments for the long term to reduce frictional costs
3. sell only when price appreciably exceeds value
In reality taking a profit can be wrong, just as taking a loss can be right; there is no absolute catch-all practice that actually stands up to proper scrutiny.
As the financial services community makes a great deal of their money from transaction charges one wonders where this mantra could possibly have come from!
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.