Don't Panic
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| Have an exit strategy |
It is said that despite its many glaring (and occasionally fatal) inaccuracies, the Hitchhiker's Guide to the Galaxy itself has outsold the Encyclopedia Galactica because it is slightly cheaper, and because it has the words 'DON'T PANIC' in large, friendly letters on the cover.
If I ever write a book on investing, I think I will include "DON'T PANIC" in large friendly letters on the cover as well. If you learn nothing else about investing, learn to not panic. The world is full of fear, uncertainty and doubt -- especially the investing world. The other day the DOW lost 400 points because of a possible financial crisis in Italy. How do you learn to relax in such an ever changing world?
Some of my most costly lessons have come from fear and panic. Sometimes a stock is rising and I want to hurry and catch it, just to have it drop out from under me. Conversely, I invested in ROKU and then read some convincing article on how it will never make money and sold it for a loss. It has since gone on to more than double my original purchase price. Fortunately, since I have been investing small amounts, these lesson I have not been too costly.
Before jumping out of an airplane, one prepares by having a parachute and making sure it works. The time to check your parachute is not while you are descending toward the ground. To make a successful jump, prepare first.
Investing is a bit like parachuting. You place your investment into an environment beyond your control and it is very easy to get carried away by what ever wind blows.
One way you prepare is to define your exit strategy. An exit strategy is a plan for when you will sell the investment. By having an exit strategy you can put aside the fear and panic knowing you can make a soft landing regardless of what the market does.
Just as you wouldn't jump from an airplane without a parachute, don't invest without an exit strategy first.
People having been investing for a long time and have developed exit strategies that work. Different exit strategies work in different circumstances. The trick is to pick the right one for the investment and your goals.
It is OK and expected to re-evaluate your exit strategy over time. Your assumptions may change and your goals may change. In these cases, make a considered evaluation of the exit strategy and change if needed.
Note about picking an exit strategy: pick one you understand. Some strategies are complex or involve having access to hard-to-get information. If you pick such a strategy, it will only add to your uncertainty and fear.
Below are a few common exit strategies. They are easy to find by searching for "stock exit strategies". In future posts, I will discuss specific investments including the specific exit strategies being used with each.
Hold
Hold is the easiest strategy to implement. This strategy is that you will hold the asset until some time external to the asset itself. You buy the asset using dollar cost averaging and then hold it until some time in your life like retirement, buying a house, paying for college, etc. It does not matter if the asset goes up or down.An IRA and 401(k) are good examples of this sort of investment. By law and under penalty of fees you will need to hold onto these investments until retirement age.
Fixed Price Targets
This strategy involves setting a loss sell order and a profit sell order. Once these are set, then just waiting until one or the other executes. This can be good if you don't have time or the tools to monitor your investments.
One drawback of a fixed price target is not being able to take full advantage of an increasing stock price.
Limit Stop Loss and Trailing Stop
This is similar to fixed price targets.
Limit stop loss is setting a sell at a point below your buy which will result in a loss. The idea is that you want to get out before it loses too much value. You can then get back in at the lower cost using dollar cost averaging.
A trailing stop is a similar idea. As the stock rises, you place a sell below the current price. As the price rises, the trailing stop is also raised. When the stock drops, the order will execute, locking in your gains. Some brokerages will do this for you, others force you to do it yourself.
The advantage to using these strategies is that you decide before hand how much you feel you can lose if things go bad while not preventing you from taking advantage of gains.
Summary
Before investing, spend some time reflecting on your goals and decide upon an exit strategy. It will save you from some fear and panic induced costly lessons.
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