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Always have an exit plan

Always have an exit plan

Lately, I was reflecting on my investing mistakes and life in general, and realized that one of my biggest weakness is not having an exit plan. Having an exit plan is important both in investing and in a career as well. Also, these days through reading more books I find that I am able to seek answers from questions that actually have very little answers to it.

Contrary to Warren Buffett’s famous quote of “Our favorite holding period is forever”, I think this is simply not that great advice given that the fundamental tenet of markets is that they are random. What I mean by this is that you cannot simply like a stock, buy a stock, and leave it there forever with no plan on exiting. Based on my personal experience, I am able to make sound investments but I always lacked an exit plan.

Source: Warren Buffett, AZ Quotes. Please, this is not sound advice in our opinion as nobody knows what lies in the future.

This has caused me to go from paper gains, to almost always paper losses. For example, I invested in the largest telco company in China back during the 2016 days back when there was still hype on 4G and 5G advancement, and since then due to structural reasons, the share price has reduced significantly.

Below I share some of my opinions and how I structure my exit plan. I would like to highlight once again that investing is very personal, and hence, you should always form your own view and see what works best for you.

A. If you buy a stock and the stock price drops by 50%

We can’t control the price of a stock and likewise, cannot control the timing of when we enter a particular stock simply because markets are random. However, you can always control your emotions and decide on an exit plan. Note: a bad plan is always better than no plan.

To share a personal example on China Mobile, which actually has extremely little debt with strong free cash flows, the share price has unfortunately come down significantly over my 5 year holding period. The IRR on this investment would be very negative, but I view this as one of my most important lessons in exiting an investment. I was initially puzzled on why such a financially sound company would be unloved, but judging from how rotation of funds have been into tech the last 5 years, it is not surprising that such “old economy” stocks will be out of favour. My plan is to reduce my loss of this investment to -30% and then move on to other investments which can generate better returns. Painful lesson? Yes. But in investing you win some and you lose some.

Source: Yahoo. Share price of such “old economy” stocks will probably never be the same again.

B. Find reasons that make sense on exiting an investment

One personal reason I use to make sense of when I should exit an investment is when say the paper gains of a particular investment is approximately the amount of my one-month salary. I convince myself that by locking in a one-month salary worth of gains, I am actually getting back the time I need to work for that one particular month. This keeps me motivated in finding stocks that have the potential to yield such a return. Likewise, this is personal, so find what works best for you.

C. Use guidelines to serve as a reference point on when to cut your losses (eg. if a stock is down 8%, you will cut your losses and move on)

I came across this article recently and thought it serves as a very good benchmark on how to cut your losses should markets or your thesis go against you.

For example, for stocks that are more value-based or have less volatile movements, you can use a range of 7-8% below your cost to act as a loss cutting point. Reason being it is better to put your capital to other better uses and accept the loss and move on.

For more volatile tech stocks, I set a range of about ~20% below my cost price or whatever I am comfortable with if I have strong conviction of a company.

Setting some guidelines will instil discipline in your investing process.

D. Double down on stocks you have strong conviction to bring down your average price

My equity research professor once told me, in equities, you still can double down on stocks as it is driven by fundamental reasons. But in commodities, you cannot since you will be margin-called and wiped out.

One personal success story that I have is ComfortDelgro, where my first investment tranche at ~$1.47 was not the most optimal. The stock price continued to slide but I still have the conviction that it was undervalued. Hence, I bought in another tranche at ~$1.34. This brought down my average price and when it recovered, it also amplified my gains.

E. Do not be swayed by forums’ “fake advice” which comes across as convincing to say a stock price can go from say $20 to $100 in a year

Lastly, with new avenues of information springing up now and then, be very selective and prudent in taking in information. Us humans are emotional creatures. Sometimes when we read such forum with random keyboard warriors saying that a price can go from $X today to $100 in a year, take it with a pinch of salt. Even you think it could be true, always have an exit plan simply because you do not know where will markets be headed tomorrow. I believe prudency and discipline will help you go a long way in your investing journey.

I wish you all the best in finding your next best stock.

What are some of the other tips that you have in exiting an investment? Share with us in the comments box below.

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Best wishes,

Finance and Toast

 



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