Kenny Rogers used to sing, “You gotta know when to hold ’em. Know when to fold ’em. Know when to walk away.”
While Rogers was referring to a gambler, the same is true in investing. Sometimes you should sell an investment. But do you know when? Investors often struggle to sell in a timely manner, but profitability depends on buying low and selling high. These are a few selling strategies that DIY investors should consider.
Rebalancing isn’t sexy, but it’s a proven strategy for contrarian thinking. Choosing to rebalance your asset allocation when its too far out of line forces you to buy assets on sale while selling overpriced assets.
Sector rebalancing offers the same protection. When you sell stocks (or ETFs and Mutual Funds) that have recently outperformed the market, you’ll naturually buy into sectors that have underperformed. Often, this will allow you to take advantage of business cycles in a positive way.
Of course, rebalancing comes with a price tag. In taxable accounts, you will be subject to capital gains taxes, and in most accounts will you will be subject to buying and selling fees from your brokerage.
Setting Stop Losses
Stop loss orders are orders for your broker to sell a position as soon as it falls below a certain price. Many investors set the price to 20-25% below their purchase price. Typically, when a stock rises in value, you should increase your stop loss order, thereby insuring profitability.
Stop losses allow investors to take the emotion out selling decision. They are an effective tool for managing your behavior, but they come with a few downsides. The first downside is that you may end up selling below your stop loss price. This happens when after hours trading leads to an opening price below your stop loss price.
A second downside is that a stop loss automatically puts you in a cash heavy position. You’ll need to buy something new to restore your asset allocation.
Tax loss harvesting
If a position in your portfolio is down, you may want to consider selling to harvest tax losses. Selling a security at a loss limits your tax liability when you’ve sold a position for a profit. This can be especially important if your profit came from short term capital gains which are unfavorably taxed.
Usually, tax loss harvesting is most successful when you can reinvest the proceeds into some security that is substantially similar to the one you sold. An example might be selling BP plc (BP) at a loss and then Purchasing ExxonMobil (XOM) with the proceeds.
The downside of tax loss harvesting is that you’re still selling at a loss, and you may miss out on a return rally.
Goal Based Selling
If you’re investing for some short or mid-term goal, you may wish to move to cash as soon as your investments surpass your predetermined goal. One example might be selling an after-tax brokerage account as soon as you can pay off your mortgage with the proceeds. You may want to move to cash in a 529 plan as soon as you’re certain you have enough to fund your child’s higher education.
Goal based selling is one of the most effective ways to ensure that your money works for you and not the other way around. Of course, if you choose goal-based selling, you’ll almost always miss out on profits in the long run.
Many of the greatest investors of all time abide by the philosophy that the best holding period is forever. If you’re a value investor, work on your nerves of steel and never sell. Dividend investors and those with extremely long term goals tend to be best served by staying in the market through the volatility.
Do you know when to sell?
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DIY.FUND was developed by a team of financial industry veterans. While building portfolio and trading systems for multi-billion dollar hedge funds, we realized the same tools are not available to the individual investor…