When Should You Sell Your Investments?
Once you have a system for which stocks to buy, you’re only halfway done with the invetment process. Eventually, you’ll need to decide when to sell your investments. Unfortunately, most investors have no idea when to sell their stocks (and often sell at the absolute worst time).
Today, we’re going to talk about the two primary reasons you should sell your stocks, and how to know when it is time to take your investments off the table.
Editor’s Note: This is part IV in ourin our multi-part series on fundamental investment principles. See also:
- Part I – What is a Fair Price to Pay For My Stock?
- Part II – Are you a Growth Investor or a Value Investor?
- Part III – How to Know Which Stocks to Buy (and When)
Stay tuned for our next installments. You can also email me (Zach@ZachScheidt.com) to let me know what fundamental questions you have about investing.
Two Primary Reasons To Sell Your Investments
When you initially bought your shares, you should have had a reason for making the investment. Maybe you thought that the shares were under-valued and you were taking advantage of a discount.
Or maybe you were impressed with a company’s growth prospects. You expected profits to accelerate and you were willing to pay a premium price for these shares.
If you had a specific reason for purchasing your shares, it makes decisions for when to sell your investments that much easier.
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Over time, you’ll begin to see whether your initial investment thesis is correct, or if the things are developing different than you expected. Of course there are many different scenarios for how your investment could evolve. But these scenarios fall into two primary categories.
Scenario 1: Things Turn Out As Planned
The best case scenario for your stocks is that all goes as planned. Maybe your value stock investment rebounds and now trades at a “fair” (and much higher) price. Or maybe your growth company launches a new product and doubles its profits.
At this point, you have one of the most difficult decisions most investors will face.
Do you sell your shares and take your profits off the table? Or do you continue to hold your shares and hope for even more gains?
When my stocks perform as expected, I always ask myself if my original reason for investing is still intact. Is my value stock still underpriced? Does my growth company still have excellent prospects? (And is that growth still enough to justify the current stock price?)
If my investments trade so high, that my initial reason for investing is no longer valid, I go ahead and sell my investments.
Too many investors fall in love with their positions when they work, and hold their stocks long after it no longer makes sense to sell these positions. While I never want to sell a stock rashly (taking a profit just because I’m afraid a stock will trade lower), I also never want to become too committed to any one investment.
And that brings up our second scenario for selling investments.
Scenario 2: Your Investment Takes a Wrong Turn
Regardless of how much research you do, some of your investments will trade lower.
It may be that you missed something in your research process. Or it may be that an unexpected development changed the outlook for your company.
At this point, it is so easy to find a new reason to continue to hold your shares.
I should know. I’ve been there before.
Maybe you think that your growth stock is now trading so low that it represents a great value. Or maybe you think that the company will hire a new CEO to turn things around. The point is, your original reason for investing is no longer valid.
This is a pivotal point that separates most successful investors from the novices.
If your original reason for owning the stock is no loner valid, you should sell it. It doesn’t matter if there is a new reason for owning the stock. It’s simply good discipline to sell your shares and step back. You can then take time to re-evaluate the new reason and make a more rational decision.
Remember, you can always buy the stock again. But as long as you’re holding your shares and continuing to shift your concept of why you’re holding these shares, you’re unlikely to make a wise, rational decision.
A Quick Word About Taxes
A couple of years ago, my friend Brad asked me about one of his stocks.
Brad had invested several thousand dollars into a hot technology stock. The position worked out even better than he imagined and Brad was sitting on more than $100,000 in profits!
There was just one problem. Brad was worried that if he sold his stock, he would have to pay taxes on the gain. He reasoned that if he waited six months to sell his shares, the gains would be “long-term” and taxed at a lower rate. This would save him $20,000 in taxes.
As we talked about the investment it became clear that this was a volatile stock with plenty of risk. The company had some major competitors that could make its technology obsolete. There was a significant chance the stock could trade lower.
I told Brad that if it were me, I would go ahead and sell the shares. Or at the very least, I would sell part of my position. That way I could lock in profits (even if I did have to pay taxes on the gain).
Brad was risking all of his profits in an effort to save $20k in taxes.
You probably know how the story turned out.
Brad watched his profits evaporate over the next six months. The good news was that he didn’t have to pay any tax on this stock position. The bad news was that last time I spoke with him, he didn’t have any gains left.
The moral of this story is clear. Don’t hold on to your positions just to avoid paying taxes. In most cases, you’re far better off paying taxes on your gains, than leaving your stocks at the mercy of the market — just to avoid paying the government.
Next Up: Generating Income From Your Investments
That wraps up this segment on when to sell your investments.
Next, we’ll discuss how to evaluate the income your stocks pay. This way, you can know how much cash your portfolio is likely to generate, and use that information when planning your retirement budget.
Stay tuned, and please feel free to email me your questions. (Zach@ZachScheidt.com)
Here’s to growing your income!