At an investment club meeting at which I was a speaker not too long ago, one lady raised the issue that has bedeviled investors since trading began: “When is the right time to sell?”
The simplistic, and completely useless, answer is when a stock is at a price it is unlikely to ever exceed. Absent a time machine, that’s impossible to know except after the fact. Given that the fortunes of the markets in general and specific stocks in particular are impossible to predict, here are some general rules you can apply in deciding whether to sell part or all of a position.
Sell When a Stock Exceeds 10 percent of Your Portfolio
It’s never a good idea to have too much of your money in a single security. If something goes wrong with the company, it will have a disproportionate impact on your portfolio’s performance.
Typically, a stock’s weighting will increase because the price has risen more than those of the other securities you own. That makes it hard to sell—it has done well for you, so why dump it? You need to be disciplined in this situation. Take some profits, reduce the weighting to 10 percent maximum (and even that is a lot) and redeploy the money elsewhere.
Sell Half When a Stock Doubles in Value
A close friend used to constantly remind me: “No one ever went broke taking a profit.” When a stock doubles in value, the first reaction is elation. The second should be prudence. The security has done well, but that doesn’t guarantee the run will continue—remember the experiences of Nortel Corp. and Research in Motion (now BlackBerry Ltd.).
By selling half the position, you take all your original investment off the table. Now you’re playing with the house’s money so you can keep riding the winner for as long as you want.
Sell When a Stock Loses Half Its Value
No one likes to take a loss, especially a big one. But losing half your stake is better than losing all of it, which does happen (again, remember Nortel). If the market has knocked down your stock by 50 percent, there’s a good reason for it.
After a drubbing like that, it’s unlikely to turn around, and your best move is to take the capital loss and exit. There’s one exception to this rule, however, see below.
When Not to Sell
There are times when you may be tempted to sell but should not. These include the following situations.
1. A Market Correction or Crash
This is the exception to the sell-when-a-stock-loses-half-its-value rule. The crash of 2008-09 saw many great companies shed 50 percent of their stock value. Bank of Montreal shares fell so low they were yielding 11.5 percent at one point.
When something this dramatic happens, you need to assess the quality of the securities you hold. Ask yourself whether the companies are likely to survive the downturn and become prosperous again when the economy turns back up. If the answer is yes, then hold on and ride out the storm.
2. Temporary Problems Within a Quality Company
Over the years, many companies have run into major problems that have severely hurt the price of their shares. A recent example is British Petroleum’s massive 200 million barrel oil spill in the Gulf of Mexico in 2010. In April of that year, just prior to the oil platform explosion and the subsequent spill, BP depositary receipts were trading on the New York Stock Exchange at around $60. By late June, they had fallen to $27, losing more than half their value.
The shares still aren’t back to their pre-spill highs, but they are trading at over $50 today. Selling at the bottom would have been precisely the wrong move.
3. Selling Would Create a Large Tax Liability
It’s always important to consider the tax implications before making a sell decision. Unloading a stock that has done well can trigger a large capital gains tax liability if the shares are held in a non-registered account.
If you feel you must sell, see if there are some losing positions that you’d like to trim back at the same time, thereby creating offsetting capital losses.
4. Finally, Don’t Sell Just Because Your Gut Tells You to
Most of us are not hardwired to make good investment decisions, especially in times of stress. Emotions should not play any role in the buy/sell process but, because we’re human, they do. Your gut may be right when it comes to personal relationships, but it will probably be wrong as far as the markets are concerned.
Logic, discipline, and common sense are much more dependable allies.
Courtesy Fundata Canada Inc. © 2014. Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, available through his Building Wealth website. This article is not intended as personalized advice.