“No one ever went broke taking a profit.” Wall Street has plenty of platitudes. Warren Buffet famously said: “Someone is sitting in the shade today because someone planted a tree a long time ago.” One of my favorites is “If you had a horse that was winning races, would you shoot it?” Clients who consider themselves stock traders can be tempted to take profits, especially in volatile markets. As their advisor, one of the ways you bring value is making the case for why they should sit tight and do nothing.

How To Buy Five Stocks And End Up With Four Losers
Let us assume a client bought five stocks. Four worked out and one did not. The client decides to hold the loser and sell the four winners. They buy four new stocks as replacements. Three of the new four work out and the fourth does not. They sell the three winners, replacing them with another three new stocks. As you can imagine, two work out and one does not. The client sells those two winners, replacing them with another two stocks. One works out.

At this point, the client has owned 10 stocks that worked out and were sold, but is left with a portfolio of four stocks. Only one is making money. The others have either declined or stayed the same.

The lesson is that it is better to sell the losers and keep the winners, even though it sounds counter intuitive. See the racehorse analogy in the opening paragraph.

Why Stock Traders Need To Be Very Good At Math
People should sell their losers (stocks) and let their winners ride. Many people are resistant to selling losers. They want to wait for them to come back. Perhaps they bought too early.

Here is the math lesson these investors need to understand: When a \$100 stock declines to \$66, it has dropped by a third in value. It declined by 33%. For a \$66 stock to become a \$100 stock (better known as getting even) it needs to appreciate by \$33 or 50%. That is a big move. To put it into other terms, the DJIA closed at 33,485 on 4/6/23. For it to make a 50% move, it would need to advance to 50,227! Most investors would think that would either be impossible or take a very long time! That is what they are asking the \$100 stock that became a \$66 stock to do!

The Government Is Your Silent Partner
We all know the tax code is written to guide the behavior of American taxpayers. If the government wants people to save for their retirement, when you make contributions to their retirement account, you reduce your taxable income for that year. They let growth inside those accounts be tax deferred.

Does the Federal government encourage short term stock trading? No, at least not according to the tax code. If you hold a stock for a year and a day before selling it, you are taxed at the long-term capital gains rate, often in the area of 15% to 20%.

If you sell anytime sooner, it’s a short-term capital gain. This is taxed like ordinary income at your tax bracket rate. For a married couple earning over \$364,200, their incremental bracket is 32%. That’s about a third! Suppose someone made the following offer: “You invest your money in this new venture. It’s your money alone. You take all the risks. If it works out, as your silent partner, I get 32% of your profits.” You would not think that was a good deal, but that is the deal the short-term trader is making! Obviously, losses can be offset against gains, but most people only think of investing to make money.

It can be tempting for clients to take profits when they see them, but part of the value you bring to the relationship is making the case for holding onto your winners if they are good, well-run companies. You probably suggested them in the first place!

Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book Captivating the Wealthy Investor is available on Amazon.