When it comes to investing, much of the focus is often placed on finding the right stocks to buy. However, knowing when and why to sell a stock is just as critical to achieving long-term financial success.
A well-thought-out strategy for selling investments can help you optimize your portfolio, minimize risks and ensure your financial goals remain on track.
Here are four factors that an investor should consider when determining “when” and “why” it’s time to sell a stock.
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1. Your investment thesis has changed.
As all good investors do, you bought each stock in your portfolio after performing your due diligence, weighing the pros and cons and evaluating the potential upsides. Has that view changed for one or more of them?
Many factors can drive a change in your investment thesis, so keep watch on the company’s fundamentals. Maybe the company has lost its competitive advantage, maybe demand for its products is waning, maybe it is being acquired, etc. The list goes on.
If the upside from your original thesis looks to be slowing or has disappeared altogether, it’s likely that stock is a candidate for selling so you can redeploy that capital into a different investment.
2. Opportunities look brighter elsewhere.
Every time you invest in a stock, you're making a choice that excludes other investment opportunities. This choice represents an opportunity cost, or the potential benefits you miss by choosing one stock over another. As you evaluate your current holding, consider whether its future prospects remain compelling enough to continue forgoing other promising investments.
Given that your investment capital is limited, even a well-performing stock might not be the optimal use of your cash if better opportunities arise elsewhere. If your current investment’s outlook starts to fade in comparison to alternative options, it might be wise to sell and reallocate your capital to where it can work harder for you.
3. You need access to your capital.
The whole point of having an investment portfolio is to build wealth so that in the future it will be available to provide cash when you need it. If that time has come (or will arrive soon), and you need more cash than is available in your checking account and other liquid assets, it could be time to sell.
It’s generally not a good idea to invest in the stock market with money you expect to need in the next year or two. Being forced to sell in a down market to raise cash is not a fun experience. Sell on terms dictated by you, not the market.
4. Market conditions are causing you to lose sleep.
For the long-term investor, I don’t consider market volatility a good reason to sell stocks. I do believe, however, that volatility combined with your temperament needs to be considered in your dynamic financial plan.
Are you comfortable with your level of stock market exposure? What if the market were to drop 20%? If the decline would create anxiety and keep you up at night, then you likely have too much of your portfolio in stocks. Whether this overallocation is a result of strong stock returns or simply putting too much new money into stocks, you should revisit your overall plan and, if you so choose, rebalance your portfolio by selling some of your stock allocations.
There is some wisdom in the investing adage “sell down to the sleeping point,” especially if you are in or near retirement.
Selling winners or losers?
If after completing your diligence and financial plan review, you determine you need to sell some stocks, but none in particular stands out, how do you choose which ones to ax?
Here’s a shortcut you have likely heard or followed in the past: “I’m not happy with this stock’s performance. It’s a loser, so I’m going to sell it.” It’s an easy decision, but not necessarily the best one.
When we label a stock as either a “winner” or a “loser,” we make that determination based on the investment’s past performance. But as we know from the ubiquitous disclaimer: Past performance is not a guarantee of future results.
It’s helpful to shift your perspective. Rather than evaluating based on past performance, layer on its prospects for delivering results going forward. How we got to today’s stock price is important, but where its value is going is what matters most.
You’ll want to stick with the ones with the most upside potential, regardless of their label as a winner-to-date or loser-to-date. Those with less potential going forward are your candidates for selling.
Keep this in mind
A few words of caution: You should never sell a stock without first considering the tax ramifications of the proposed sale. Never make buy or sell decisions in a vacuum.
Selling a stock is a significant decision that requires careful consideration of various factors, from your need for liquidity to changes in your investment thesis. By approaching the sale of stock with the same diligence and strategic thinking as you use when making a purchase, you can ensure that your actions align with your goals and financial plan.
Remember, the decision to sell should be informed by where the stock is likely headed, not just where it’s been. Ultimately, a well-planned approach to selling stocks can help you maintain a balanced, resilient portfolio that supports your journey to financial independence.
As always, invest often and wisely. Thank you for reading.
This article is for informational purposes only. It is not intended to be, nor should it be construed as, legal, tax, investment, financial or other advice.
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