Holding Your Nerve: The Art of Letting Winners Run in Investing

One of the most persistent and damaging tendencies in portfolio management is the premature selling of high-performing assets. The impulse to crystallise a gain after a stock has appreciated significantly is deeply ingrained, yet it stands in direct opposition to the mathematical reality of equity returns, where a small number of outlier companies drive the majority of market wealth. Commentators such as the user thexcapitalist on X frequently advise against this, noting that while a stock’s downside is capped at a 100% loss, its potential upside is theoretically infinite. This concept, however, is more than just a pithy observation; it points to a fundamental misunderstanding of return distribution and the behavioural biases that prevent investors from capturing life-altering gains.

An effective long-term strategy requires a framework that can override these flawed instincts. It involves appreciating the profound asymmetry of stock returns, recognising the psychological traps that lead to poor decisions, and focusing relentlessly on the health of the underlying business rather than the noise of its daily price fluctuations.

The Skewed Reality of Market Returns

Equity market returns are not normally distributed; they exhibit a strong positive skew. This means that while the median stock’s performance is often underwhelming, a small cohort of exceptional performers generates returns so large that they pull the entire market average upwards. Research by Hendrik Bessembinder famously highlighted this phenomenon, finding that from 1926 to 2016, just 4% of all listed US stocks accounted for 100% of the net wealth creation over and above Treasury bills.¹ Selling one of these rare winners simply because it has doubled or tripled in price is akin to leaving the stadium halfway through a star player’s record-breaking performance.

The human brain, it seems, is exquisitely designed for survival on the savannah but rather poorly optimised for navigating the exponential realities of equity markets. We intuitively struggle with non-linear growth, leading to a consistent underestimation of what a truly great company can achieve over a decade or more. The decision to hold is a bet on this positive skewness, an acknowledgement that the potential reward from one generational company dwarfs the combined losses from several failed investments.

Behavioural Hurdles to Holding

If the mathematical case for holding winners is so compelling, why is it so difficult in practice? The answer lies in behavioural finance, which identifies several cognitive biases that compel us to sell too soon.

The most prominent is the disposition effect: the documented tendency for investors to sell assets that have increased in value while holding onto assets that have dropped in value.² This behaviour stems from a combination of loss aversion—where the psychological pain of a loss is felt twice as intensely as the pleasure of an equivalent gain—and a desire to prove an initial investment thesis correct, even when faced with contrary evidence. Locking in a gain provides immediate psychological relief and a sense of validation, whereas selling a loser forces one to admit a mistake. This leads to portfolios cluttered with underperforming assets, funded by the sale of their most promising holdings.

Furthermore, investors often become anchored to their purchase price. A 100% gain feels like a monumental achievement, prompting a sale without any updated analysis of the company’s forward-looking prospects. A disciplined investor must continually re-underwrite the investment case, asking not “how much has it gone up?” but rather, “if I were uninvested today, would I buy this company based on its future potential?”

A Framework for Deciding: Signal vs. Noise

Advocating for holding winners is not an argument for blind loyalty. The crucial discipline is distinguishing between a deteriorating business and a volatile stock price. A robust framework for selling should be based almost entirely on fundamentals, not price action.

Reasons to Re-evaluate and Potentially Sell

• Fundamental Deterioration: The company begins to show sustained declines in key metrics such as revenue growth, profit margins, or return on invested capital. This is a signal that its competitive position may be eroding.
• Broken Thesis: The original reason for investing no longer holds true. Perhaps a new technology has disrupted its industry, a key patent has expired, or a new management team has altered the company’s strategic direction for the worse.
• Capital Misallocation: Management makes a series of poor decisions, such as a value-destroying acquisition or taking on excessive debt for low-return projects.

Mere price volatility, market-wide panics, or even concerns that a stock has become ‘too expensive’ on a simple valuation multiple are rarely, on their own, sufficient reasons to part with a superior business. History is littered with great companies, from Amazon to Nvidia, that have looked persistently overvalued for years while continuing to generate extraordinary returns.

The Quiet Compounding of Tax Deferral

Beyond the potential for exponential growth, there is a more prosaic but powerful reason to avoid frequent selling: tax. In the UK, capital gains on assets held outside of tax-sheltered accounts like ISAs or SIPPs are subject to tax, currently at 20% for higher-rate taxpayers on most gains.³ Each time a winner is sold, a portion of the capital is permanently lost to the tax authority, reducing the base upon which future returns can compound. Holding allows gains to compound on a pre-tax basis for years, or even decades, a significant and often underappreciated advantage.

Conclusion: Patience as an Active Strategy

The ability to hold onto a winning investment is not a passive act of idleness. It is an active, often challenging, strategy that requires conviction, emotional discipline, and a relentless focus on business fundamentals. It demands that an investor overcome the powerful behavioural biases that scream for the safety of a realised gain. The data is clear: disproportionate returns flow to those who can identify exceptional businesses and then demonstrate the patience to let them compound.

As we look forward, a speculative hypothesis emerges: the greatest portfolio risk over the next decade may not be a market crash, but a pervasive ‘concentration-phobia’. This fear could compel investors to prematurely sell their stakes in the handful of truly foundational Artificial Intelligence companies that will likely come to dominate the global economy, thereby missing the most significant wealth creation cycle since the dawn of the internet.

References

1. Bessembinder, H. (2018). Do Stocks Outperform Treasury Bills? Journal of Financial Economics, 129(3), 440-457. Retrieved from https://ssrn.com/abstract=2900447

2. Shefrin, H., & Statman, M. (1985). The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence. The Journal of Finance, 40(3), 777-790.

3. HM Revenue & Customs. (2024). Capital Gains Tax rates and allowances. GOV.UK. Retrieved from https://www.gov.uk/capital-gains-tax/rates

thexcapitalist. (2024, August 28). [Don’t sell too early. You don’t need to sell just because the stock went up too much]. Retrieved from https://x.com/thexcapitalist/status/1896568137459679691