I had to make a hard decision this week – I broke up with a client.

 

My wealth management practice is a collection of amazing people – all of you know this first hand because like likes like. And because fit is so very important to me, I aim to ensure that there is a professional and a personal fit before taking on each and every client because my intention is to be your advisor for as long as we both shall live.

 

So while it was hard to admit it, the professional fit with this client was no longer there and I did what I believed was best for the both of us and wished him all the best.

 

Hard decisions like these are made every day, some more emotional than others, but a hard decision that need not be an emotional one is the discipline around knowing when to break up with a stock in your portfolio.

 

The decision to sell an investment can be influenced by a number of behavioral biases and external pressures, which, if not addressed, can cause investors to approach the sale of winning and losing positions differently and allow past experiences to cloud investment decisions.

As a disciplined investment & wealth advisor, I use the same criteria to assess the merits of new and existing investments. If a holding no longer meets my buy criteria, it should be reviewed and potentially sold; in other words, if I wouldn’t be inclined to buy more while it’s on sale, I need to think twice about why I own it in the first place.

 

In practice, my team and I find that the decision to sell a stock can be predicated on three common situations:

 

1. The first situation is driven by risk management considerations. Rebalancing positions that have significantly outgrown their original weighting in the portfolio helps limit concentration risk. Failure to adhere to this simple tenet can result in outsized position sizes and expose a portfolio to undue risk.

2. The second situation involves a shift in an investment’s risk-reward proposition – i.e. being mindful of the fact that a stock’s outperformance can alter its risk-reward proposition. Unrealistic market expectations or an extended valuation can cause the bar for continued outperformance to be reset at a higher level that will prove more challenging to meet or exceed. These are instances where I will likely reduce the position in order to accommodate more favorable risk-reward opportunities.

3. The third situation involves a material change in outlook that draws the initial investment thesis into question (i.e. bad news in the media). In these instances, decisions are at the greatest risk of being influenced by behavioral biases such as loss aversion (reluctance to sell losers) and status quo bias (reluctance to change one’s view). This is why the best defense is to be aware of these potential pitfalls, stick to a well-defined thought process and reassess investments in a rational manner.

 

So, while breaking up may be hard to do, a well thought out decision based on principles will likely result in some short term pain and long term gains.