Investors who bought shares in Rolls-Royce (LSE:RR.) in October 2020 are up around 660% on their purchase. By anyone’s standards, that’s a huge return.
With that kind of gain, it would be natural to want to sell at least some of a stake in the company to lock in profits. But I think investors ought to be very careful about doing this.
Risk
If I had an unrealised return of 660% from Rolls-Royce, the most obvious reason for thinking about selling would be to try and manage my risk. This might come in a couple of forms.
One is diversifying my portfolio. With one of my investments up by so much, I might want to take some of the cash that I had invested there and buy something else to spread out my risk.
The other is that I might simply be concerned about the stock going down. After a meteoric rise, it would be a pity to see my profits fall away if the stock dropped.
Either of these makes it natural to at least sell enough of my stake to get my initial investment back. That way, I won’t end up losing money regardless of what happens after.
I can see why this strategy makes sense to a lot of people, but I think it’s a bad idea. Selling a stock just because it’s gone up isn’t a great way to go about investing, in my view.
Opportunity cost
The biggest reason I dislike this idea is that I don’t think it necessarily reduces risk. Suppose I have a £7,600 stake in Rolls-Royce and decide to sell £1,000 to get my initial investment back.
This means my £1,000 is safe (for now) but the problem is that I have to work out what to do with it – either invest it elsewhere or keep it in cash. Either option is risky.
Putting it into another asset – a different stock or a bond – isn’t a guaranteed winning strategy. If that asset does less well than Rolls-Royce shares from this point forward, then I’d have been better off not selling.
Equally, keeping it in cash is tricky too. If the stock continues to rise, I’ll be giving up a future return by keeping my £1,000 on the sidelines.
In short, there’s a risk that comes with selling part of an investment that investors should take seriously. It’s the opportunity cost of giving up the returns those shares would have provided.
When to sell?
There’s an old saying that it’s impossible to go broke by taking a profit. While that’s true, the point of investing isn’t to avoid going broke – it’s to make money.
I’m a big fan of diversification in general, but I wouldn’t sell a stock that was up just to diversify. There might be risk in hanging onto it, but there’s also risk in selling and buying something else.
As a result, I think investors ought to think carefully before selling Rolls-Royce shares after a 660% rally. Sometimes, when a stock is up, it’s because the company has found a durable way of making money.
