Every day, thousands of articles are written about buying stocks. Far fewer are written about selling stocks. And almost none are written about the boring part in between.

This is a shame because the part in between is what matters most. This isn’t just because that’s where the compounding takes place. It’s also where individuals can exploit their two most realistic sources of edge over the professionals.

An investment edge is an advantage you can use to reach your financial goals. Here are the four main types of investment edge:

  • Informational edge - access to more or better information
  • Analytical edge – better use of the same information
  • Behavioural edge – better control of emotions and actions
  • Structural edge – absence of career or industry pressures faced by professionals

We think behavioral or structural edges are the most realistic ones for investors to pursue.

We’re not saying you shouldn’t try the others. But how likely is it that you will have an information or analytical edge over the millions of highly paid finance professionals worldwide?

What is likely, though, is that you face considerably less short-term performance pressure.

Professional investors live and die by quarterly and annual performance. As a result, a lot of them find it very hard not to constantly adjust things in the hope of improving short-term results. Trust me, I used to write fund commentaries and saw the number of trades.

The absence of these pressures is a potential edge you shouldn’t take lightly.

  • You can craft and judge the performance of your investment approach based on your goals and required rate of return, instead of obsessing over beating the index.

  • You can look past a “not great” short-term outlook to buy shares in a company with good long-term prospects at a depressed price.

  • You don’t need to sell a good holding just because the share price briefly outpaces the underlying business. Who cares if it falls back a little next month?

To avoid spurning this edge, you must focus on avoiding mistakes that nullify it. Perhaps the biggest mistake – which I have been guilty of in the past – is overtrading.

The main causes of overtrading

I think that overtrading has three main root causes. First is shiny new thing syndrome. The stock idea you’ve spent hours researching for the last few days is more exciting than the one you bought a few months ago. The hours you spent researching it also feel like a sunk cost. Selling the old stock and pressing ‘buy’ for the hot new idea feels good.

Then you have FOMO (fear of missing out) and loss aversion (fear of losing money). These are most likely to hit during periods of volatility. When markets and certain stocks are going up like crazy, it can be hard to watch from the sidelines. When something you own is going down, selling means it can’t go down anymore. Doing anything – absolutely anything – makes you feel like you have some control.

These three causes of overtrading all stem from trading on emotions instead of taking a deliberate approach. So when it comes to reducing the urge to overtrade, thinking out your approach and writing it down is the best first step. For an excellent guide to crafting a deliberate investment strategy, try this article by my colleague Mark LaMonica.

The rest of this article will focus on investments themselves. How can you approach buying investments in a way that makes you less likely to overtrade? Here are a few ways I, a recovering tradaholic, have approached it in my portfolio.

Investments I see as companies, not stock tickers

Checking your portfolio a lot can have a strange effect on your eyesight.

Do it too much and your holdings start to look less like ownership shares in businesses and more like a bunch of daily gains and losses. This isn’t healthy. Seeing stocks as a daily price quote rather than part ownership of business is the dividing line Benjamin Graham draws between investment and speculation.

One way to combat this is by investing in businesses you can see in the real world.

As an example, I own Diageo (LON: DGE) shares and loved seeing Christchurch Airport covered in Baileys adverts last Christmas. I remember thinking that even if the stock fell 10% that day, it probably wouldn’t change the fact that their tiramisu flavour Baileys looked like a must-try. Nor would it stop people in the airport bars or duty free from buying pints of Guinness and bottles of Smirnoff or Johnnie Walker.

Seeing companies you own in the real world is a nice reminder that a stock quote and the business are not the same thing.

Companies I’d happily own through the next recession

Recessions and ‘systemic events’ like the GFC are a fact of life – especially if you are investing over many decades. Would you happily own your current positions through the next one? I think this is a valuable question to ask. If you’d be happy owning a company through the next recession, surely you’ll be OK with a few 2% daily moves either way.

When I think about companies that meet this criteria, Berkshire Hathaway (NYS: BRK.B) is always the first to mind. They have always kept a very conservative balance sheet with lots of cash for two reasons. Number one, to prepare for big pay-outs in their insurance and reinsurance businesses. Number two, to go bargain shopping during market panics and emerge stronger.

Credit: I first heard this expressed on a podcast appearance by Bill Smead, a value manager from the US. Another gem he dropped in an interview with my old colleague Stephen Clapham: “A portfolio is like a bar of soap. The more you touch it, the smaller it gets.”

Knowing why I own something

Peter Lynch’s famous quote tells investors to “know what you own, and why you own it”. I think Lynch originally said this in regards to what your investment thesis for the share is. This makes sense because it gives you something real to judge your investment by, rather than daily price movements. I’m going to take this piece of advice from a slightly different angle, though.

At Morningstar, we advocate an approach called goals-based investing. Where instead of starting with which investment to buy, you start with the goal you want to achieve and your required rate of return. Knowing this helps you form your investment strategy and refine your criteria for holdings. Making more deliberate decisions in the first place makes it easier to stay the course.

As an example, my colleague Mark LaMonica is an income investor. His ideal investment is a company with competitive advantages, operating in an industry that isn’t subject to rapid change. He hopes this will allow the company to maintain and grow its dividend over time. Here’s a podcast snippet of him telling Shani why he didn’t sell Automatic Data Processing (NAS: ADP), even when it traded at very high valuations a few years ago:

“The criteria I use to sell something is if it no longer meets my investment criteria. At no point did ADP come close. It has a low business uncertainty. It continued to raise the dividend. The sources of sustainable competitive advantage still applied as customers faced high switching costs. So, in short, nothing about my original thesis had changed. The company still aligned with my investment strategy.”

Making sure I have enough money in the first place

You should not invest in equities unless you can leave the money completely untouched for at least 4-5 years. Otherwise, it’s likely that you will be too scared of short-term losses to avoid fiddling with your portfolio.

The early days of my investing journey were marred by well-researched investments that I didn’t make any money from. Not because the stocks I picked didn’t go up, but because I didn’t have enough money to stay invested until they did. I wrote about it here in my article 'How I set myself up for investing failure'.

Forced sales like this were essentially the same as an investment manager needing to sell down their positions due to fund redemptions – a structural drawback of professional money management that I am supposed to be able to benefit from.

If you don’t have enough to leave an equity portfolio untouched, get yourself into that position first. As I said in my article 'Are you too focused on investing?’, this is what I am currently doing in my non-retirement finances.

How do you ensure you can stick with your investments for the long-term? Let me know by emailing me at [email protected].

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