Q. I keep seeing the value of this stock I’m watching go up. So I’m considering selling one of my mutual funds that hasn’t done much this year to buy the stock. Since it’s an IRA, I don’t have to worry about taxes. Is there anything else I should consider when making this decision? — Chris in Viera
A. Chris, two things come to mind. One is diversification and the other is the pursuit of yield.
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By switching from a mutual fund to the stocks of a specific company, you reduce the level of diversification since mutual funds typically hold stocks of many different companies. The result of a fund’s broader holdings is that, on average, the ups and downs in a mutual fund’s price are typically about half those of individual stocks.
This change you are considering may or may not pose a problem depending on how much of your net worth you want to use for this transaction. Putting a small percentage of your net worth on one stock might be palatable, but putting your entire life savings on the stock performance of just one company is very risky and, frankly, downright stupid for most people.
The value of the share should fluctuate significantly more than that of the fund. Recently, it has been increasing more and more and catching your attention. It sounds like it invokes a little FOMO – the fear of missing out. Don’t let this tempt you into the habit of striving for returns.
Yield hunting happens when you sell underperforming stocks to buy something that has been performing well recently. That sounds reasonable, since nobody wants to own a latecomer, but this approach probably won’t yield good results over time. Even the most successful stocks, funds, and other investments underperform for long periods of time. A mere delay is not necessarily a reason to sell.
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Each time a weak holding is sold, the successor to the holding must perform well above average as it has to make up lost ground from the weak holding that was sold. Additionally, psychologically, FOMO can make it difficult to sell high performers, so there is a tendency to stay until the good performer wears off or disappears altogether.
If you’re not careful, you’ll end up having to switch from one position to another quickly in order to succeed. You need to sell good stocks before they go bad and sell bad stocks out of fear they won’t turn around. They create a situation where you have to move quickly from one place to another in order to be successful. It’s the investment equivalent of the arcade game Whack-a-Mole.
In Whack-a-Mole, the player hits the mechanical mole’s head with a hammer, which makes it jump up before falling back into its hole. Every time a mole is hit, the player gets points. What makes it challenging is that the play area has multiple holes for a mole to emerge through. The moles then appear randomly and don’t stay awake for long.
Many people approach the financial markets this way without even realizing they are doing it. It seems logical to buy or hold on to things that have worked well and throw away things that haven’t worked.
However, history shows that the need to switch quickly from one holding to another is an unlikely proposition in the financial markets. This is more of a speculation than an investment. Certainly some people succeed, but they are the minority and as time goes by, fewer and fewer people succeed in following this approach.
The arcade game has a frenetic, chaotic quality that can make it fun to play. If you like to think of your investing as a game, that’s your choice, but for most people, prudent long-term investing is probably a better life savings strategy.
Dan Moisand, CFP® is Past National President of the Financial Planning Association and has been recognized as one of America’s Top Independent Paid Financial Planners by at least 10 national financial planning publications. For more information, visit www.moisandfitzgerald.com or call 321-253-5400, ext. 101
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