Whether on TV, on the radio, or from your third cousin at the Thanksgiving dinner table, there is a lot of chatter dedicated to the discussion of which stocks are hot buys.
For many investors, buying and researching what stocks to buy is fun and interesting. Others are lured in by the chance to pick the next big winner.
The desire to identify a great stock pick taps into our human nature. We love to talk about what investments to integrate into our portfolios in the hope we turn a profit.
Conversely, our human nature can sometimes make it difficult for us to let go of a stock, whether that stock has done poorly or it has been on a ship to the moon.
You’ve probably noticed, but there isn’t a lot of discussion over the airways on the decision of when to sell a stock. This could be because it can feel like a tricky decision to make. And the decision isn’t easier whether that stock has done really great or if it has been a total dud.
Here are some ideas you could keep in mind if you own stock and are wondering when to sell a stock for profit or when to sell a stock at a loss.
Why selling stock is hard
If you’re having a difficult time making a decision about whether to sell a stock, you’re not alone. This decision can tap into a lot of different human emotions.
For example, humans can experience something called loss aversion, where they have a physical reaction to the thought of losing money.
The thought of selling stocks at a loss can trigger this emotion, and it can make it hard to sell even when a person logically understands that the money could be better used in another stock or investment. We may want to hold onto that investment, hoping that it improves.
On the flip side, knowing when to sell a stock at a gain can be equally as difficult. After a stock has a precipitous rise, it can be tough to sell because the inclination is to believe that the stock may continue to rise.
This feeling could be exasperated by hubris, the feeling that it was because of your intelligence that the stock has done so well, or good old-fashioned greed (which is a totally natural reaction).
Beyond the ways our brains are working against us, there is no universal protocol for selling stocks. There are no rules for making a good decision.
And often, there is no one right answer, because knowing how a stock will move forward requires knowing what will happen in the future. Good luck with that.
Trying to time the market
Before discussing valid reasons you may want to sell a stock, let’s talk about what might not be a good reason to sell a stock: Making a knee-jerk reaction to the recent performance of that stock.
This can be classified as attempting to time the market. Even the experts cannot always buy at the bottom and sell at the top. Know that there is no perfect equation and that it is not science.
It can be tempting to sell a stock based on a big dip or bump in price, but the recent price movement alone might not give a complete picture of the current value of a stock.
It may help to remember that a stock is something that trades in an open marketplace and that prices shift due to the buying and selling of these stocks.
This is especially the case in the short term. Therefore, price changes may have as much to do with investor sentiment or outside forces (such as geopolitical or economic events or announcements) as they do with the health of the underlying company.
When you might sell a stock
There are several reasons you might want to consider selling a stock. If you’re currently in this position, you may want to weigh several of these ideas against one another.
Please note that none of these methods amount to a recommendation, but are ways to think about the same decision from within different frameworks.
1. When you no longer believe in the company
When you bought the stock, you presumably did so because you believed that the company was promising and/or that the price was reasonable.
If you were to believe that the underlying fundamentals of the business were in decline, it might be time to sell the stock and reinvest those funds in a company with a better outlook.
Most businesses won’t last, or be successful, forever. That’s simply the nature of running a business. There are many reasons you may lose faith in a company’s underlying fundamentals.
For example, the company may have declining profit margins or decreasing revenue, increased competition, new leadership taking the company in a different direction, or legal problems — among other things.
Part of the trick here is differentiating what might be a short-term blip in the stock price due to a bad quarter or even a bad year and what feels like it could be the start of a more sustained change within the business.
2. Opportunity cost
Every decision you make comes at the cost of some other decision you can’t make. When you spend your money on one thing, the tradeoff is that you cannot spend that money on something else.
The same goes for investing — for each stock you buy, you are doing so at the cost of not holding some other stock.
No matter the performance of the stock you’re currently holding, it might be worth evaluating to see if there could be a more profitable way to deploy those same dollars.
This is easier said than done because we are emotionally invested in the stocks that we’ve already purchased. It may be a good idea to try and be as objective as possible during the evaluation and re-evaluation processes.
3. The valuation is high
Oftentimes, stocks are looked at in terms of their price-to-earnings (P/E) ratio. The market price per share is on the top of the equation, and on the bottom of the equation is the earnings per share. This ratio allows investors to make an apples-to-apples comparison of the relative earnings at different companies.
The higher the number, the higher the price as compared to the earnings of that company. A P/E ratio alone might not tell you whether a stock is going to do well or poorly in the future.
But when paired with other data, such as historical ratios for that same stock, or the earnings multiples of their competitors, it may be an indicator that the stock is currently overpriced and that it may be time to sell the stock.
A P/E ratio could increase due to one of two reasons. First, because the price has increased without a corresponding increase in the expected earnings for that company.
And two, because the earnings expectations have been lowered without a corresponding decrease in the price of the stock. Either of these scenarios tells us that there could be trouble for the stock on the horizon, though nothing’s a sure bet.
4. Personal reasons
Though not an analytical reason to sell, it is possible that you may need to sell a stock for personal reasons, such as needing the money for living expenses. If this is the case, you may want to consider a number of factors in choosing which stock to sell.
You may make the decision based purely off of which stocks you feel have the worst forward-looking prospect for growth while keeping those that you feel have a better outlook. Or, you may make the decision based on tax reasons.
The ubiquitous saying goes, “don’t let the tax tail wag the investment dog,” meaning that tax strategy shouldn’t outweigh making decisions based on investment principles. Still, some people may take the rules of taxation into account when making decisions about which stocks to keep and which stocks to sell.
When purchased outside of a retirement account, gains on the sale of an investment like stock are subject to capital gains tax.
It may be possible to offset some capital gains with capital losses, which are acquired by selling stocks at a loss. If you’re considering this strategy, you may want to consult a tax professional.
If making the decision about when to sell a stock is causing you to lose sleep, or is something you don’t feel ready for, it may be time to consult the help of a professional or seek out investment strategies that don’t require making such a decision.
To hire the help of a professional, you might want to bring someone on who will act as your fiduciary.
Fiduciaries are required by law to make recommendations in the client’s best interest. A fiduciary could be an individual, a financial planning firm, or an online investment service and platform.
Funds, whether they be mutual funds or ETFs, generally hold many other investments.
For example, an S&P 500 mutual fund (or ETF) holds all 500 companies held in the S&P 500 index. With the purchase of just this one fund, you are actually buying into the 500 stocks that are currently measured by the S&P 500 index.
In this way, many funds are already diversified investment holdings. For many people, they may be a solid strategy for long-term investing.
With a fund-based buy and hold strategy, you could largely avoid the decisions involved in managing a portfolio of stocks, such as when to sell stocks and when to hold onto them.
When choosing funds, you might want to consider the composition (what types of stocks are held within the fund) and the fees involved with owning the fund.
Also, you may want to differentiate between index funds and managed funds. Index funds mimic some particular part of the overall stock market and don’t involve an active manager.
Just as it sounds, managed funds have an active manager making decisions about what stocks are held within the funds. Managed funds are typically more expensive than index funds, so be sure to make sure the fee is worth it.
There’s no doubt about it, managing a portfolio of stocks can feel like a full-time job. What to buy and when to sell at a loss or when to sell for a profit might all be considerations on an ongoing basis.
Investment portfolios require upkeep, and so either an investor does it or they hire someone or a service to do it for them. Ultimately, it will be up to the investor to decide which of these makes sense for them.
Original source: Mediafeed.org