Knowing when to sell stocks, as we point out from time to time, is one of the most pitfall-riddled aspects of strategic investing. Selling is a skill nobody ever masters.
Real-estate investors have an old and valuable maxim: “You make your profit when you buy.” You can say something like that about investing in stocks, because strategic portfolio planning can overcome a lack of selling skill. But here are three reasons to sell.
Take the money and run
First, there’s the ‘glad-to-oblige’ or ‘take-profits’ sell. Sometimes, high-quality stocks become much too costly and are inevitably headed for a fall. That’s why another name for this is the ‘take-the-money-and-run’ sell.
A stock’s temporary costliness can occur when it becomes what’s known as a ‘market-darling’—a stock everyone feels they must own. This happened with Nortel Networks. Back when it was flying high, we wrote, “It’s quite possible that Nortel Networks may weigh too heavily on your portfolio. In this case, you might consider taking some profits from this manufacturing company. The fact is, occasionally it makes sense to rebalance.” Around the same time we wrote, “Our advice remains to take profits from Nortel if you’re a conservative investor.”
Other factors can make even high-quality stocks too costly. These include a takeover bid that might fail, a short squeeze (when short-sellers panic and rush to buy back shares they previously borrowed and sold), or a rising stock market that acts like the tide that lifts all boat, or a stock that rises slowly but surely to the point where it’s simply over-priced.
Get out because you have to
A second type of sell is the ‘get-out-only-because-you-have-to’ sell. When your strategic investment objectives change—due to aging, job changes or whatever—you sometimes need to sell high-quality stocks for reasons that have nothing to do with fundamentals and may, in fact, run counter to them.
Your best bet here is to get out gradually, over a period of months or years. Above all, side-step the mistake of waiting until you have to sell. Wait until then and you may wind up selling at a market low.
As always, you should keep your circumstances and investment strategy in mind. Let’s say, for instance, that because of your strategic investment objectives you only own stocks that we rate as ‘Very Conservative’ or ‘Conservative’. If we lower our rating on one of your stocks to ‘Speculative’, ‘Higher Risk’ or even ‘Average’—then you should sell, regardless of our buy-sell-hold advice because such a rating does not fit your objectives.
Don’t keep all your eggs in one basket
A third type of sell is the ‘I’ve-got-all-my-eggs-in-one-basket’ sell. Mr. Andrew Carnegie, the 19th century billionaire-turned-philanthropist, once quipped: “Put all your eggs in one basket—and watch that basket very carefully.” But as the owner of U.S. Steel, Mr. Carnegie had access to the kind of insider information individual investors lack. So that investment strategy suited him.
But it likely doesn’t suit you. Say, for example, that you own a lot of Magna International and AutoCanada Inc., both Key stock buys. Trouble is, they both have significant exposure to the cyclical auto industry. As a result, we would recommend in this case that you sell one or the other or a bit of both.
Going broke taking profits
Almost as important as knowing when to sell, is knowing when not to sell.
Successful mutual fund manager Peter Lynch says it’s critical not to sell out of fear.
One common mistake is to sell to nail down a modest profit when the best is yet to come. In other words, selling stocks that go up for small profits. This, as we’ve often pointed out, is a good way to filter all the profit out of your investments. If you sell what goes up, you’ll never have a big winner—and you need a few big winners to cover your inevitable losses.
In fact, one highly-successful investor we know summed up a great deal of strategic investment planning wisdom for us some time ago when he explained his success with the offhand comment: “I was smart enough to buy Canadian Tire at $0.50, and too stupid to sell when it hit $2.00.”
With the aid of hindsight, it’s always easy to see which stocks should have been sold and when. But nobody (least of all us) has a buy-sell record that measures up to hindsight. Just remember that you can go broke taking profits.
The Investment Reporter, MPL Communications Inc.
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