By: Eva Sadej
Blueleaf’s position: Creating and sticking to a coherent selling strategy can ensure that you lock in gains and minimize losses. It’s important to know your exit plan – be it account rebalancing or an eye on company fundamentals – for every position in your portfolio so you don’t get left behind.
Before you even buy a stock, you should know the price and circumstances under which you plan to sell it. This is your exit strategy and having a clear, articulated selling strategy is necessary for making sure your emotions don’t get in the way of your investment objectives. It’s hard to let go when something has treated you so well, and it’s even harder to admit when you have made a mistake. Selling a stock at the right time under a well-formed selling strategy can do as much to help you hit your goals as finding winning stocks in the first place.
The better you do in the stock market, the higher the percentage of individual stocks in your portfolio and the riskier your portfolio will be as it becomes more concentrated in those “winners” [link to individual stocks article]. Having a sensible selling strategy is important in rebalancing your portfolio, but there are also numerous other reasons why selling a stock may be a good idea. Here are some good reasons to sell a stock.
Perhaps the company’s fundamentals have worsened. Think back to why you purchased the stock. If you consider yourself a value investor, did you invest in the business because it had strong fundamentals and have these fundamentals changed? Is there a new CEO who is professing to take the company in a new direction that you do not agree with? Have earnings declined for two sequential quarters? Perhaps a company that you believed could sustain itself is now being acquired? Has a product pipeline deteriorated? If the reason you bought stock in the company is no longer there, then you’re hanging on to is a poor move. Always know what you own and why.
Perhaps it has become too expensive. Perhaps you invested in the company because you believed that the stock price plummeted unduly due to investor fear with a new competitor entering the market. Perhaps you generally believed that the stock price was too low compared to competitors and that the company had excellent growth prospects. Has the P/E ratio gone out of whack? Perhaps now the stock price has reached a new height and become overweight. Perhaps it has surpassed its true value and is now set up for a fall in price? If you invested for a great value, your motive is no longer there and though you may be proud of the stock, it is time to sell.
Perhaps it has underperformed. Can you find a better value elsewhere? If you are keeping your cash invested in an underperforming stock, you are losing money due to both opportunity cost and inflation. Once the stock has hit sell price or wavered around it for too long, you’ve lost enough money and cutting your losses to put your money in a more profitable stock is probably more worthwhile. Sometimes the best move is to just walk away. And rather than adding more money into stocks, it is best to sell the underperformers and find new value propositions elsewhere. Don’t wait until you break even! You’ll get your money back sooner if you don’t wait.
Perhaps the stock price taken a drastic downturn. This is tricky. Try to understand what caused the decline and whether it is a temporary shock or a more permanent drop in performance. Ideally, you should have sold the stock before such a drastic decline but if you have not, look for a cause and determine whether selling is justified or not. Look to the future of the company, not the past, and reassess whether projected future cash flows regardless of the temporary paper loss warrant holding on to the stock.
Perhaps you just need the cash. Do you just need to raise cash for a major purchase or for living expenses? Your stocks are as much your money as your savings account. Liquidating your underperforming investments (but only those) is nothing to be ashamed of.
But don’t forget taxes. If you are debating whether to hold onto the stock a little longer, consider the benefit of holding for a year so that you can avoid paying short term capital gains. However, don’t hold onto a loser just because you want to hit the long-term capital gains threshold. Your investment decisions should primarily be about your investment theses and adherence to a concrete selling strategy; tax implications should always be a secondary consideration.