Recently, I came across an investment tip called the Overnight Rule from Carl Richards via the NYT Bucks Blog:
Imagine that all your investment holdings were sold overnight by accident.
You can’t undo the trades, and now all you have is cash.
Would you buy back everything you owned previously again at their current prices? If not, why are you holding them now?
I think this provides a fresh look at your portfolio, as many times we hold investments for irrational reasons. For example, there is the well-documented trait of loss aversion (even though readers of this blog may be immune), where investors really hate selling at a loss, even more than they love selling with a gain.
Perhaps you bought the stock at $20 a share, and it is now at $15 a share. You want to get rid of it “just as soon as it gets back to $20 a share”, so that so you can say you didn’t lose money on it. It’s better to admit the mistake and put your money in something better.
Then there is regret aversion. Perhaps you bought it at $50 a share and now it’s at $400 a share. You get to tell your friends how you bought Apple at $50 a share. You’re afraid it’s overpriced, but you don’t want to miss out if it rises some more. You sit on your gains and choose inaction instead of having to make a hard decision even though your money could be better deployed elsewhere.
Maybe it is company stock from your job, or shares that you inherited from a beloved family member. Whether is it some form of sentimental attachment, inertia, or plain laziness – you may want to consider your reasons for holding them.
There is a small exception to this rule if you are sitting on large capital gains in a taxable account and don’t want to realize them and get hit with the tax bill, especially if the alternative investment is also very similar (ex. mutual funds with similar holdings). However, even in this scenario you want to make sure that you’re not holding a poor investment just to put off a tax bill.
I did not come up with this myself, but read about this rule somewhere online within the last month. I’ve searched for the source but can’t find it, so please let me know if you do. Found it, thanks!