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There's no perfect formula on when to sell stocks. In investing, it's one of the most challenging questions to answer. There are plenty of books, tutorials, and articles teaching investors on how to analyze a stock and when to buy them. However, there is less research and attention given to the concept of something just as important: when should you sell a stock in your portfolio?
Hey, welcome to stock market mate. Today, we'll talk about when to sell stocks. Before we star to it. This dilemma isn't something new. When stock prices decline from where you bought it, you might need to decide whether to give up and sell it or hold on to it until prices cool off. In some cases, the stocks you bought might increase in price quickly and you decide to put profits into a different stock.
Investors should have a financial plan that outlines their investment and financial goals for the short and long term. There is no universal, one-size-fits-all strategy for selling a stock. Instead, it's up to the individual investor's investment strategy based on many factors, including their risk tolerance, time horizon, and financial goals.
But thankfully, experts like Lynch and Buffet did not keep their investing tips a secret. If you’re planning to sell your stocks, there are things to consider before executing it. Determine your time horizon Lynch is an advocate of maintaining a long-term commitment to the stock market. According to Lynch, the key to knowing when to sell, is knowing "why you bought it in the first place." This is why an investor must determine their time horizon before purchasing stocks or any type of investment.
If an investor has a long-term time horizon, they can likely ride out market corrections or downturns. However, if the money is needed in the short term, such as less than one or two years, investors will likely have a different strategy for holding or selling their investment. Each investor will also have a different financial goal, depending on their age and when they need their money.
If an investor is 25 years old, they might hold their investments for several years. Conversely, if an investor is a retiree or close to retirement, they would likely have a shorter time horizon, particularly if they need the cash for retirement income. Consider your risk tolerance One of the most successful investors of all time, Warren Buffet, said “Risk comes from not knowing what you are doing”.
This is why before you sell your stocks, you need to consider your risk tolerance. Risk tolerance is the level of risk an investor is willing to take for each investment. Some investors will forgo a significant rate of return in order to achieve lower risk. For example, U.S. Treasuries are considered risk-free assets as long as they're held until their maturity or expiration date.
In return, investors are paid a rate of interest. However, U.S. Treasuries would likely underperform stock investing. An investor with a higher risk tolerance would likely put their money in stocks, such as an index fund that tracks the S&P 500. Understanding risk tolerance, investors can develop a strategy for what types of stocks to buy, how much money to allocate to stocks versus bonds, and when to buy, sell, and hold their investments.
The Buy and Hold strategy Warren Buffet likes to buy stocks at bargain-basement prices and hold them patiently. As Warren once explained in a letter to his partners, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” If investors are holding an investment for the short-term or less than one year, they might sell the stock as soon as it makes a capital gain or when they need the cash.
However, you should consider Buffet's long-term strategy: the buy-and-hold, which is a passive investment strategy in which an investor buys stocks and holds them for a long period of time. Buy and hold investors are less concerned with short-term fluctuations in the stock market. Buy and hold investors typically choose stocks based on a company’s long-term financial fundamentals, such as the company's revenue or profit potential.
Also, these types of investors tend to look for companies with a strong management team and a consistent track record of generating earnings from sales. However, even buy-and-hold investors might need to sell a stock at some point for a profit or loss. As a result, investors should be aware of their purchase price and any change in the company's fundamentals.
REASONS TO SELL A STOCK It's usually a bad idea to sell a stock only because its price decreased. At the same time, though, sometimes you just have to cut your losses on a stock position. It's important to not let a drop in a stock's price prevent you from selling. As legendary investor Warren Buffett says, "The most important thing to do if you find yourself in a hole is to stop digging." If your original reason for buying a stock no longer applies, or if you were just plain wrong about the company, then selling at a loss rather than continuing to hold may be your best option.
With this in mind, you need to firmly clarify your reasons on why you want to sell a stock. So here's a rundown of five scenarios that can justify selling a stock: 1. The company is being acquired Another potentially good reason to sell is if a company announces it has agreed to be acquired. After an acquisition is announced, the stock price of the company being acquired typically rises to a level close to the agreed-upon purchase price.
Since further upside potential can be quite limited, it may be wise to lock in your gains shortly after the acquisition announcement. 2. Your investment thesis has changed The reasons why you bought a stock may no longer apply. Examine why you bought a stock in the first place and ask yourself if those reasons are still valid.
You should have a reason or an investment thesis for each of your stock investments other than just wanting to make money. Of course, this list isn't exhaustive. If something substantially changes that contradicts your investment thesis, that's one of the best reasons to sell. 3. You need the money or soon will It's generally a best practice not to invest in the stock market with any money you expect to need within the next few years.
But if you need the money, that's certainly a valid reason to sell. Perhaps you want to purchase a house and sell some stock to cover the down payment. Or you may have children who plan to attend college in a few years, and you want to convert your stock holdings into more secure investments such as certificates of deposit.
4. You need to rebalance your portfolio Your investment portfolio can become unbalanced in one or more ways. That is why periodically rebalancing your portfolio, which may involve selling some stock, is necessary for most investors. 5. You identify opportunities to better invest your money elsewhere In a perfect world, you'd always have spare cash to invest for every time you identify an attractive investment opportunity.
Since that's probably not the case, you may decide to sell stock to invest the cash differently. Let's say you notice an incredible buying opportunity for one of your favorite stocks and decide you want 10% of your portfolio to be allocated to this investment. If you don't happen to have 10% of your portfolio sitting in cash, you may decide to sell some shares of another stock or exchange-traded fund or ETFs you own to free up some capital.
There's likely nothing wrong with the other stock or ETF, but recognizing an excellent long-term opportunity elsewhere can be a valid reason to sell. Deciding Which Stocks to Sell Before selling, it's important to consider which stock will be sold first because it can impact your tax situation. Typically, a stock that's sold is done so on a first in, first out basis unless otherwise stated.
For example, let's say you bought 50 shares of a company every year, and over the course of four years, you paid $10, $15, $20, and $15 per share, respectively. Suddenly, you need money for an emergency and the stock is trading at an all-time high of $25 per share. If you decide to sell 50 shares, typically, the first year's shares at $10 per share would be sold.
If you want to hold onto those shares, you can select which shares to sell at the time you place the sell order. In other words, you can select the shares that you paid the most for, which can lessen the amount of capital gain and, as a result, the amount of taxes paid. Of course, if you sold the shares with the $20 purchase price for $25, you'd only have a gain of $5 per share realized.
If the stock price falls back to $15, you would have missed out on earning a $15 per share profit on the shares bought in the first year for $10 per share. So bottomline, be very careful when selling stocks and make sure your reasons are justified. Selling an investment is like buying one—you have to make sure it is in line with your investing and financial goals.
Also, it's important to understand your risk tolerance and time horizon. If you found this video helpful, kindly click the like and subscribe button. Also, you might want to leave a comment below. We love hearing from you. Thank you for watching and we’ll see you in the next video.
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