Sell or buy more is one of the most sound advices in money management that I’ve ever heard. Basically, every time you are reassessing your stock holdings and find a stock underperforming heavily, you should ask yourself: should I sell or buy more?
To implement this framework, one must always keep some ammunition available, which means that you cannot be completely invested at all times. Therefore, your capital allocation will be suboptimal, but it will give you plenty of maneuver margin. Since investors are more likely to cut small losses than big losses, in the long run, we can expect this strategy to produce small losses and big gains.
Adding the fact that, usually, investors have a terrible timing for buying, by starting small and periodically adapting, investors will increase the opportunity to either cut losses or increase their holding at a lower price.
There isn’t a perfect market strategy in the same way there isn’t a perfect crime. Any strategy will always have some flaws. In this case, one might be continuously compounding a mistake. The solution is to keep a minimal degree of diversification. Even in a concentrated portfolio composed by 5 stocks, if one performs badly, yielding a loss of 50%, your portfolio would have lost only 10% (50% loss times 20% of the total assets) – a manageable loss.
The “sell or buy more” approach works, not because it’s a flawless strategy, but because it makes you reassess your investment rationale, while at the same time even a small degree of diversification will avoid huge losses.
This is a simple concept, some will say that’s just dollar cost averaging, but I think it is a bit more subtle than that. In reality, sell or buy more is a philosophy that makes you rethink your whole rationale in a given stock and forces you to take some action.
I’ve become acquainted with this approach while reading the book “The Art of Execution: How the world’s best investors get it wrong and still make millions in the markets” by Lee Freeman-Shor. In this book, the author, a Fund of Funds manager, brings to the table several years of experience dealing with fund managers and stock pickers. A very interesting read for investment professionals.