|How's your Disposition?|
This is the kind of choice that reveals a lot about your investment style and your behavioural biases. In my case, I have to hold my hand up to a very common bias - I don't like selling losers: its called the Disposition Effect (i.e. 'disposing' of winners too early). Does this make me a bad investor?
I need the cash to take up one of my allotments of First Group shares (that difficult choice will have to be the subject of another post), so I sold the best performer in that particular brokerage account - BAE Systems, which had risen in value by about a quarter, a value equivalent to over 4 years' dividend income (close to my 'sell' signal of capital gain of more than 5 times current dividend income).
So this is what you might call a 'technical' sale - there is no real reason to sell: no bad news. It's just cashing in some more chips.
So what about holding onto losers? Isn't this fixating on the purchase price (the Disposition Effect always has this as a reference point), which might be irrelevant in the wider scheme of things?
My perception is that, the price of dividend shares tends to be more volatile when things go wrong. Although in the market it seems that dividend shares are seen as 'safer' - and they do tend to be less volatile (perhaps drawing an analogy with bonds): the higher the firm’s dividend yield, the lower is it’s stock price volatility. However, when problems occur, the share price can lurch quite dramatically, producing eye-watering losses in the short term - 50% or more.
Sometimes dividend shares do 'go bad' and selling a loser is the only pragmatic thing to do (as the business case may be completely shot). But generally the 'fallers' or bad performers seem to often recover - although this might take a while (I'm talking years).
The alternative is to operate a system of stop-loss sales, which just does not suit my temperament. As I have noted in other posts: your investment style is shaped largely by your emotions. In particular, I don't really want to have to tinker with my investments on a daily basis: I want to be able to go on holiday for a couple of weeks without having to worry about my portfolio or being knocked out of a position by a sudden triggering of a stop-loss.
After living through the nightmare of the 2007/08 downturn, I can live with a sharp loss in portfolio value because I know that the income of my portfolio is not as volatile as the market value of the securities. This is the great advantage of being an DIY Income Investor.
However, as many investors are prone to the Disposition Effect, it does mean that is probably a sub-optimal strategy, as the clever hedge funds have worked out that investing against this behavioural bias can be successful. Be aware that the US tax system may influence the tone of the academic research on the impact of this bias - something that is irrelevant for an investor in a tax-protected account like the UK's ISA or SIPP.
For me, the price I pay and the yield I buy are like benchmarks. After all, I generally try to buy dividend shares that have good 'value' credentials (low p/e, low debt, good business model etc.). If the price falls, I am still receiving the same income (assuming the dividend remains the same) and I can hope that the 'value' elements of the company will help the share price to 'come good'. If the price rises, the current yield falls, and this is an indicator of a potential 'opportunity cost': the capital could possibly be moved to a higher-yielding investment that would provide more income. And I do try to maintain some sort of discipline with my capital-gains-more-than-5-years-income rule before I sell. Most of the time, at least.
So, I confess, I suffer from the Disposition Effect. It seems obvious that this will negatively affect the success of my investment activity - for example, compared to an emotionless automated hedge fund 'bot' - but the size of the overall impact is perhaps debatable, particularly if tax is taken out of the equation. However, it is illogical to value losses more than gains.
To err is human, it seems.
[Sale price: £3.947]
I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.