Sometimes selling winners makes sense

I ask investors if they would buy an investment at its current price.If the answer is no, then it is not wise to continue holding it, says Harsh Roongta

Classical investment theory says that we should hold on to our winners and sell our losers, if needed. I was reminded of this when I met Sunil, a 40-plus executive with a multinational corporation. Sunil had a few good equity mutual fund investments and fixed deposits, but a significant part of his investment was tied up in a house (not his residence) which he had bought around 10-11 years back, fuelled by a low-cost loan from his employer and the great deals on offer in the aftermath of the 2008 crisis. Sunil now needed funds for his daughter’s overseas education and had approached us for advice on how to fund that goal.

Sunil was justifiably proud of the property investment whose value had risen around five times over the past 10-11 years to around Rs 2 crore now. He revealed that the property was bought purely for investment, and fortuitously, the timing had turned out to be perfect both in terms of the purchase price and the development of the area in which it was situated. The rental yield and the low interest cost meant Sunil had managed to pay off the loan ahead of time and the property was loan free now.

We worked out the options for Sunil. One, sell the property and the cost of education would not only be fully funded but there would also be a surplus left for retirement. Two, sell all investments other than the property and take a small education loan to fund the gap. But it would mean that apart from his Employee’s Provident Fund, the only other asset left would be the property. Three, take an education loan against the property. But loan servicing would impact his or his child’s future cash flows unless he sells the property in the future. Four, a combination of options two and three.

When asked, Sunil agreed that the property is unlikely to provide the same rate of appreciation in the future as it had in the past. Even though selling it appeared to be the optimal option, Sunil was reluctant, considering it had done so well for him. “How can you advise me to sell my winner?” he asked. I explained that the concept of holding on to winners applies in the context of evaluating between selling an investment that is a winner (and is likely to remain so) against a loser investment. In his case, none of the alternative investments was a loser. And, in any case, they were not sufficient to meet his needs. More importantly, the property was unlikely to do as well in the future. Sunil understood the logic but remained reluctant.

In the end I asked him, “If you had Rs 2 crore lying in fixed deposits, would you buy this property now?” Sunil was quick to answer in the negative. He felt property prices had run their course. After that question forced him to do a zero budgeting on the investment, it was not difficult to convince him that by not selling the property at Rs 2 crore, he was effectively buying it at that price. I have found this question on whether the investor would buy an asset at the current price a great way to break the decision-making logjam when the latter develops an entrenched attitude towards an investment.

I have found it particularly useful with investors who do not sell an investment because its price is below their cost price (loss-aversion bias). When asked, such investors will be vehement that they will not buy the investment at the current price. At that point, at least for some investors, it is a relatively easy leap to make that by not selling at the current price, they are effectively buying it at that price.

The writer heads Fee Only Investment Advisers LLP , a Sebi-registered investment adviser