Investment: The toughest decision

Plenty of investors face the same dilemma right now: equity markets have had a good run since late last August, when Federal Reserve chairman Ben Bernanke signalled a second round of stimulus in the US. But the end of easy money is now in sight, oil prices are rising and inflation is becoming a more pressing problem in many parts of the world. These are all, on the face of it, bearish signs, and yet many equity markets remain close to their highs. If trouble lies ahead, there are few obvious signs of it yet.

So what to do? Should you sell, locking in profits but shutting yourself out of any further gains? Or should you stay put and hope to secure a bit more upside?

Private investors are routinely criticised for selling successful investments at the first sign of a profit, and holding on to losing positions in the hope they will come right. “Sell your losers and let your winners run” is a common piece of advice, sometimes attributed to the great American trader of the 1920s, Jesse Livermore. But on its own, this maxim is only marginally helpful. Letting your winners run into the autumn of 2008 would have been a disaster.

On the other hand, the first Lord Rothschild is said to have remarked: “The greatest profits I ever made were by selling too soon.” This makes intuitive sense and it also speaks to a deeper, psychological truth.

First, a profit is only a profit when it’s cash. I can’t take a paper profit to Tesco. Second, Rothschild’s comment betrays his fundamental outlook: here is an investor able to take a decision and live with its consequences, rather than berating himself for not holding out for a few dollars more. Sure, sometimes one will miss out on huge additional upside this way, but often one won’t.

In truth, there are no right answers to questions like this, only answers we can live with and others that we can’t. Just as you have to decide what scale of loss you can tolerate and then take it, so you must do the same for your profits. They are two sides of the same psychological coin.