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money judgement

The eternal struggle of when to sell stocks and funds has hit home for me. While we’d like this process to be very mechanical, it’s actually very emotional, and that can be dangerous if you aren’t able to control your emotions. Here’s a simple guide to help protect yourself from making silly mistakes or becoming overly emotional (I first set out two rules, then turn them into one rule).

My story is that I’ve been planning a trip with a couple of friends to vacation through Southeast Asia, and it’s about to happen – we’re buying tickets now. One of those friends flies out frequently for work, so he knows the area relatively well, and has a made a number of friends and connections that can help us when we’re there. So, I need to free up some cash so I can buy the tickets as I keep as much as I can invested (and growing) until I need it.

Selling some portion of funds to pay for this, which I’ve been planning, so I know I have the money saved, makes the when-to-sell question quite easy. I sell when I need it, which is rule #1:

Rule 1 – Sell when you need it, not when you don’t. You invest your money for a future purpose, so you should sell when you need to take an action. Remove the environment of the market from the equation as the market doesn’t react to your specific situation.

Now, I hadn’t set a date ahead of time for selling because the plans haven’t been set in stone until a few days ago. The best way to go about this, as it removes as much emotional reaction as possible, is to pick a date as much as a week or two ahead of schedule, and set it in stone through some auto sell-by-date option. You should be able to set a sell date when setting up the sale, but in my case, I just said sell now.

To my fortune, the fund has gained a few percentage points in the last couple of days because the market seems to like the fact that a regularly scheduled FED announcement said they wouldn’t raise interest rates (and probably for a few other reasons too). Had I focused too much on this coming announcement, I may have tried to sell early because I expected bad news, or I might still not want to sell as I planned because I’m reacting to what the market did (either hold longer if I expect more gains, or hold longer because I want to recover from some loss). As you can see, I’d no longer be focused on the reason I actually want to sell, which is my trip, but instead because of expectations I have with the market – expectations that I have no control over or real way of understanding (beyond flipping a coin).

Rule 2 – Don’t plan your sale around short-term shifts in the market. The market doesn’t move around your life plans, so don’t plan around the market. This is when you get emotional because you don’t know what will happen, and worrying about short-term gains (or losses more often) will only lead you into a lose-lose situation. You already have a good reason for selling, so keep your eye on that.

Since this is a blog about removing complexity, and keeping personal finance simple, I’m stopping at 2 rules, and really it could be one rule:

2 Rules as 1: Selling is about planning, not reacting, so sell for a reason like needing the money for a specific purpose or regularly planned rebalancing (if you do this). With the exception of catastrophes (and even then probably not), don’t planning around market expectations because they will bite you in the butt.

To finish, lets assume that I let my emotions take over, and I sold based on my market expectations, and lets also assume I lost money by holding onto the fund after the announcement. Now, I’ve been scarred by this. Humans hate loss, and we do what we can to protect ourselves. Next time there is an announcement, I might feel anxious and want to sell for no reason other than avoiding a temporary loss, which actually costs me money in transaction fees to move the money around, and that’s a loss in itself.

If you go down the road of reacting to the market, the short-term market, then you’ll start to become like many of the traders I used to know who would get anxious, maybe even losing sleep, about potential loss and overconfident about gains both of which they had little control over. Even trying to predict the long term market has big risks, which is why holding the whole market is in most cases the best option (in both risk and return).

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Along with conceptual discussions, I’m sure people would appreciate some explanations of the mechanics behind personal finance such as setting up a high interest rate savings account. And since at this time, my parents are the only ones reading this, and I’ve been telling them about high interest rate savings accounts, it might help walking through the steps of actually setting this up.

There are a number of sites that do this such as ING Direct, HSBC, and Emirates. They all have different rates, which will fluctuate slightly over time such as when the Fed rate changes, but they’re all pretty similar, so pick the one that suits you. These are savings accounts, but most savings accounts have low rates, which are much lower than money market accounts and stocks and bonds as well. The major draw back to traditional savings accounts is that they won’t provide a return greater than inflation, which is how much more things will cost you tomorrow compared to today as prices rise, so the money you keep in that account is worth less tomorrow unless you get a return greater than inflation.

Traditionally, the next step up for better return is a Certificate of Deposit (CD). These are higher return assets that pay interest for a fixed period of time, and like bonds these are considered Fixed Income. The problem with this is that your money is locked away until the maturity date of the CD, which is considered low liquidity.

Solving this problem, some financial institutions have been innovating their business models in ways that reduces their overhead and allow them to offer these much better rate accounts. These are still new in the market, though, and not everyone is sold on them, but they are FDIC secured, so at the least the US gov has you covered for up to $100k. The benefit of these accounts is that they provide near CD returns while maintaining the liquidity of the asset. You can withdraw and deposit money when you like (sorta). One downside to keeping your money in these accounts, like any savings account, is that you pay income tax on your interest earned, which is almost always higher than the taxes you’d pay for capital gains on equity such as from money you make from selling stocks and index funds, but more on taxes another time.

Directions

I have an account with ING Direct, so I’ll explain the basic steps involved with them. Goto http://home.ingdirect.com/, select Open An Account, and under Orange Savings select Open Now. A number of steps are required such as entering your personal information and accepting terms and conditions, which are all pretty standard. The one different step is making an electronic deposit. All that this requires is a check book, you should have a checking account already at some bank, and you enter the routing number and whatever else from the check. Enter the amount you’d like to deposit, and you’re done – almost.

In the next few days, once they’ve processed this information, they’ll deposit two amounts of money – something less than a $1 (mine were something like $0.01 and $0.03) – and you log into your account, and enter those two amounts to verify that they’re attached to the correct checking account. Now, you’re done. The amount you original intended to deposit will be electronically transfered, and from your ING accounts you can transfer money back and forth between your original checking account (or other checking accounts that you attach later), which takes 2-3 days to clear. Now you have a much higher interest rate and you keep the great liquidity.

Note: there aren’t any ING branches to get your money out from, so you’ll still have to rely on your original bank, but these are great for emergency spending accounts where you don’t plan on spending the money, need liquidity, but don’t like getting only 1% or so. Additionally, you might not like the risk of putting that money in the market. I only use this for my emergency funds to keep it as simple a possible. I don’t check up on this account much, so it’s a great out-of-sight out-of-mind barrier to wanting to spend this money.