Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 344

The power of letting winners run

Most investing missives focus on finding and backing winners. The logic makes sense. One of the better ways to enhance portfolio performance is to improve the feedstock of investments into the process. The downside is that strategy around portfolio management often gets short shrift.

A challenging aspect of portfolio management is the handling of extreme winners and losers. It tests both the process and psyche of portfolio managers but also how they manage the positions within the overall portfolio.

Dealing with extreme losers is the most common problem. A 2014 study by J.P. Morgan found that, over 25 years, 40% of all stocks in the Russell 3000 index suffered a catastrophic loss of 70% or more from their peak. Another study by Blackstar Funds found that 39% of stocks had a negative lifetime total return. Big losses happen with surprising frequency.

All those losses can make for a pair of silver linings, though.

The first is that, because losses occur so frequently, investors get plenty of experience on how to handle them and have developed clear frameworks for how to manage extreme losers.

The second is that, at least when wrong on the long side, the position size has shrunk and whether the portfolio manager decides to sell is of much less consequence.

The challenge with extreme winners

Handling winners is a more complex task, especially at the extremes. Conventional wisdom is keen on locking in profits with some form of the saying such as “You never go broke taking a profit.”

But locking in profits on winners cuts against the defining advantage of investing in equities: losses are capped while gains are not. The lean-but-long right tail of winners overcompensates for the limited losers. The same J.P. Morgan study found that only a third of stocks manage to beat the benchmark. In other words, it’s a small subset of winners that more than make up for a huge chunk of losers.

Closing out a winner purely for the sake of locking in a gain snuffs out the long tail of potential upside. For example, the BlackStar Funds study found that 6.1% of the stocks in its 24-year study of the Russell 3000 outperformed that benchmark by more than 500 percentage points.

Imagine having an approach to selling which embraces locking in a profit at a 50% gain only to find out that the sold stock then outperformed the benchmark by nine times the size of your profit. Even if the benchmark went nowhere, it would take another nine-plus 50% gains from other positions to make up for the forgone gains. A fundamental approach that embraces locking in small gains in stocks can make for the worst of both worlds: it retains the risk of loss but eliminates the long tail of potential upside that more than offsets the regular flow of losses.

Worse, the odds of an investor catching lightning in a bottle with the proceeds of selling a winner are unlikely given that the base rate says that roughly two-thirds of stocks underperform their benchmarks. The more times that process is repeated, the more likely an investor cashing in winners is to generate benchmark-trailing results.

There are two other good reasons to err on the side of not rushing to sell winners.

The first is that study after study, including the beautifully titled Trading Is Hazardous to Your Wealth, reflects that portfolio turnover is inversely correlated to performance. On average, these studies all point to the average high-turnover investor underperforming the average patient investor.

The second is for tax: longer holding periods can allow for more favourable taxation on individual gains and make for fewer tax drag pit stops on the compounding journey.

Where the rubber meets the road

And so logic would say that letting winners run is a sensible plan for the typical long-term investor. As usual, though, the answer on whether and how far to let an individual stock run begins with an “it depends”.

For starters, know that having a long-term approach is not an excuse to not stay on top of new information and how a thesis is evolving, even if that investment is working out well. Indeed, as a position swells to take up more room in the portfolio, so should it gobble up more of the portfolio manager’s mindshare.

Investors who let winners run should also brace for a more concentrated portfolio as the winners expand and the losers shrink. Greater concentration typically also makes for greater volatility, which can unsettle some investors. I personally prefer backing my best ideas with conviction as it suits my temperament and is well supported by empirical research.

There’s also the matter of valuation. Almost every runaway winner looks conventionally expensive at some point, making for a greater chance of a drawdown. That said, outside of broad-based macro factors which affect most stocks (e.g. falling interest rates), companies that get re-rated higher usually do so for a very basic reason: the fundamentals have improved and are beating expectations. As a long-term, high-conviction investor, my Darwinian bias is to let such companies grow to be a larger part of my portfolio and let those that fall short shrink.

Just how large a position size that is tolerable for an individual investor is a function of that person’s individual circumstances, including their willingness and capacity to take that risk. What suits me may not suit you. Big picture, though, long-term investors would do well to ponder what kind of returns they may be leaving on the table by ‘locking in a profit’ next time around.

 

Joe Magyer is the Chief Investment Officer of Lakehouse Capital, a sponsor of Firstlinks. This article contains general investment advice only (under AFSL 400691) and has been prepared without taking account of the reader’s financial situation. Lakehouse Capital is a growth-focused, high-conviction boutique seeking long-term, asymmetric opportunities.

For more articles and papers by Lakehouse Capital, please click here.

 

9 Comments
Robert
February 20, 2020

An old economist's take: develop a linear decision function which prescribes for you an: " x%-gain -> y% sell down of the holding by value " action at each time point on the linear time scale...then if the share price retreats a% at a future point, and IF YOUR REASON FOR ORIGINALLY BUYING THE STOCK HAS NOT CHANGED SIGNIFICANTLY, top up the stock by b%.
Adding another element of complexity: if the stock increases c% from the b% top up point/stock price, and IF YOUR REASON FOR ORIGINALLY BUYING THE STOCK HAS NOT CHANGED SIGNIFICANTLY, then this signals a further potential run-up by the stock, so top up by a further d%. Your risk tolerance - and [dare say] overall mental stability - should determine what % you use each time [5%, 7.5%, 10% or whatever] ...and of course that % can be slightly adjusted over time because [as we all know] the only-constant-thing-in-successful-investment-is-change..

= A mechanical process that takes away the need for potentially dangerous subjective judgement...and remember: 1. if you think a stock is imploding, dump it - you can always return to it later [maybe]. 2. if not a stock imploding, a price fall is probably only a reflection of a relatively small number of holders selling to take profits, getting cold feet or simply needing the capital tied up in it for other purposes. 3. Everyone is a genius after the event [the CSL lamenting in the "comments" to the post, a classic example] and no one will EVER be an investment genius before the event 4. betting on the stock market is not that much different to betting on a favourite jockey, saddle cloth number, or race favourite in horse races....and every bet has it's uncertainties and risks...and a savvy approach [decision function] is paramount in managing every evolving financial risk and uncertainty!!

Good luck everyone

John Wilson
February 12, 2020

This is an issue which hasn't received the attention it deserves. All of us get bombarded with "take money off the table", "minimise losses", "diversify" etc. These are all good advice, but what about the other side of the coin - "let winners run". The problem is how to make the decision to get out or to let a holding run.
Most of us have held CSL at some stage: it is a freak. In 1994, I decided it was worth a go, and bought the 2000 guaranteed allocation in every name I could think of - as I recall, there were 14000 shares in the names of me, my wife, our kids, the family trust etc. I was thinking of getting some in the dog's name. I sold all but 2000 when the price reached $8 - I had "achieved a great profit", and subsequently sold some to get a "better" weighting.
If I had a crystal ball and held on to those shares, after the 3 for 1 share split and the price rising to $330, those parcels would now be worth almost $14m!
There must be some way of seeing this. When I originally bought in the float, I thought CSL was a good business. Why didn't I hang onto more?

Richard Rouse
February 12, 2020

Sir
I have been involved in the share market as a sole trader, starting off in a small way in the late 1980s. I was interested in your comments on letting your profits run. In June 1994 I bought 2200 shares in the CSL float
@ $2.30. I sold these in Jan 1996 @ $4.07, a profit of $4220 incl. divs & brokerage, or ~46% in 18 months.
As a beginner, I thought I was pretty smart, but seeing as those shares today are worth $726,000, it has been an expensive lesson. I think I have learnt from this and other experiences, that it is better to buy and hold than to be a trader, provided you do it right.

Andrew
February 16, 2020

Richard, the 3 for 1 share split means your holdings would have been worth $2.178m.

Rod
February 12, 2020

A case for the Trailing-Stop-Loss!?

SMSF Trustee
February 12, 2020

Rod, only if you went into it as a trade rather than as an investment decision designed to earn long term income with growth. An investor, rather than a trader, will decide to exit because they no longer believe that the income will be delivered and that income growth is no longer possible, not merely because the market is volatile!

RJM
February 12, 2020

Agree Rod, but "Trailing-Stop-Loss's" easy to model hard to action! (in my experience) Greed Vs Fear!

Gary M
February 12, 2020

Agree, but there are also many examples of companies that have run hard, and they are now well off their highs or dead. Axcesstoday is one the market loved and now even bondholders have lost money. Sometimes, it's best to take some chips off the table.

Justin D
February 15, 2020

Agree Gary but I think Joe refers to investors selling quality businesses because price may be running at highs where the businesses have bright prospects ahead. A good example to your point would be NAB. Today's share price was the share price it had in 1999 but I don't think Joe based this article on the likes of NAB.

 

Leave a Comment:

RELATED ARTICLES

Why buying speculative stocks often proves irresistible

Finding the next 100-Bagger

Preparing for next decade's market winners

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.