The How And Why Of Profit Taking

A street with a church in the background

How many of you have had a security that you’ve held too long, waiting for those unrealized profits to materialize once again. Will GE, for example, ever regain the $20 mark? $40? Or the $60 level that investors couldn’t get enough of twenty years ago?

How many of you are approaching retirement holding large positions in equities and/or funds that aren’t paying much income but can’t be converted to income production because of painful tax consequences?

For an investor, a day without a profit is like a fine meal without wine.

There are reasons why many investors: “sell their losers and let their profits run”, but in the forefront is their failure to use the “four great risk minimizers” in their security selection/retention process. Attention to quality, diversification, and income production allows investors to confidently tread water during corrections. Profit taking at reasonable levels allows them to compound the benefits of a rising market and avoid painful taxation at the worst possible time (in retirement).

If you select only the highest quality securities, diversify properly, and generate income from every selection, you will be able to set reasonable target profit levels for everything you own, knowing that you will be able to find similarly suitable replacements.

I’ve never met a profit I didn’t like, and regular “realization” of gains produces a personal retirement portfolio that owes nothing to Uncle Sam.

Wall Street wants you to remain heavily invested in the stock market, even in retirement income portfolio “models”… because they “know” that any correction will be short lived. For retirees and soon-to-bes, this is a risky strategy, particularly when most models pay 2% or less in spending money.

Here’s the read-between-the-lines sales pitch: “Attention investors: stocks are at the highest prices in the history of mankind; buy now, and sell your income securities if there is a correction.”

Should you be interested? Would you be in any other aspect of your life? Are higher prices a sign of greater safety, or of greater market risk? Does it really make sense to liquidate income purpose assets during corrections because “the stock market always comes back… eventually”.

By the way, market risk is totally different from financial risk… you can minimize the latter with quality, diversification, income, and profit taking. Market risk is Mother Nature’s financial twin sister… an unavoidable annoyance.

Instead, you need to reprogram your investment self to lovingly take profits during the upward momentum of rallies. Similarly, you must embrace the opportunities to purchase high quality securities at lower prices as the media starts whining about the next market correction.

Recently, an early morning caller raised this question: “Why so many smallish profits?”, referring to the profit taking spree that has been playing out in my managed portfolios since 2019, and through most of 2020. Because they are there now, and may not be tomorrow… and because reinvestment opportunities are always available (in “smallish” positions) in CEFs, was my answer.

No one has ever become poor by taking profits.

The market has always been a roller coaster ride, but with none of the important characteristics (highs, lows, volatility, or duration) predictable, by anyone, no matter how well credentialed… and

There really is no such thing as a “bad” profit.

It has become clear to me over forty years of muddling through the investment exercise, that most mistakes are made by people who either over simplify or over complicate their process. The cyclical nature of markets, long term; and the shorter term volatility of equities are fairly obvious forces that we will always be able to take advantage of.

Smart portfolio management would have you seeking quality (equity) additions to your portfolio inventory during stock market corrections. You need to develop the disciplines, rules and procedures needed to take advantage of both long term cycles and short term volatility.

Profit taking is a bonus income producer and the risk minimization tool that investors use least. From a compound earnings perspective, a lot of “smallish” profits work much harder than an occasional “biggie”.

If you take losses during broad corrections, or chase the market darlings that push rallies ever upward, you may be on the wrong track. The stock market always moves up and down… you need an approach that makes market volatility your VBF!

Recent market highs have created itchy-trigger-finger short-covering and other forms of speculation that may gobble up even the memory of past corrections. But sooner or later, some financial gurus will declare the market “overbought and fraught with danger”.

Try to think of “profit taking” as you would a “now or maybe never” year end bonus from your employer… are you ever going to say no because of taxes?

There’s no right or wrong here people, no good or bad… just some simple truths that make markets ever fruitful for experienced decision-makers who can accept and adapt to directional change.

Always, yes always, buy too soon during corrections… and take profits too soon during rallies.

It is also extremely helpful to buy smaller than usual quantities at either market extreme (in both your equity and income bucket) and to recognize that CEFs make it easier to do so in a safer, well diversified, and liquid environment.

Extra credit question: What came first, Closed End Funds or Mutual Funds?

Have you joined the Closed End Fund (CEF) education group on Facebook? It’s time to share your story, or to start a new one. Here’s the link: