Every gambler knows / That the secret to survivin’ / Is knowin’ what to throw away / And knowin’ what to keep / ‘Cause every hand’s a winner / And every hand’s a loser / And the best that you can hope for is to die in your sleep.–Don Schlitz and Kenny Rogers
Nobody ever lost money taking a profit.–Bernard Baruch
We don’t know if Kenny Rogers and Bernard Baruch ever met. (Mr. Rogers was only 26 years old when Mr. Baruch died.) But we’re pretty sure they would both agree with The Investment Reporter’s view that the hardest decision most investors face is knowing when to sell a stock.
It’s easy to understand why many investors find deciding when to sell stocks so hard—even harder, in some cases, than deciding what to buy in the first place. After all, selling wisely can increase your profits.
Few investors, of course, like to sell when stocks are down. When stocks are up, on the other hand, there’s always the chance that they will rise still further: Nobody wants to sell when their stocks may only just be starting to gain momentum.
Sooner or later, however, you’re likely to sell. Over the years we’ve found that making the right decision on when to sell your stocks is much easier if you define your investment objectives before you buy. And write them down.
By keeping your objectives firmly in mind when you set out to build your balanced, diversified portfolio, you will minimize the need to sell because, say, your individual choices fail to match your overall objectives.
Keep your investment objectives in mind
You may still have to sell to provide funds in an emergency—temporary unemployment, for instance. However, you should reduce the risk of being forced to sell by setting up an emergency fund to cover such unexpected cash needs.
Then, too, no matter how painstakingly careful you are when you choose stocks, some of your choices will inevitably fail to live up to your expectations. When this happens you should sell—provided you’ve waited a reasonable length of time and there’s no reasonable chance of improvement. At least here you will be selling because you should sell—not simply because you need the cash.
It’s often a mistake to simply sell because a stock has gone up—especially if investment fundamentals indicate the stock has excellent prospects of a further increase in price. Similarly, selling because a stock has gone down may also be a mistake provided the stock has the prospects to bounce back quickly.
Prior to 1972, capital gains were not taxed. But in 1971, Ottawa introduced capital gains and loss tax legislation. While no one likes to pay taxes on their capital gains, you can at least say this much for it: Investors are not as quick to take profits when doing so means they must pay tax on half of the increase in the value of the stock.
At the same time, investors find it easier to sell at a loss if investment fundamentals tell them that’s what they should do. Ottawa lets you use your capital losses to offset capital gains.
In short, the capital gains and loss tax rules encourage investors to hold on to their better performers (to put off paying taxes) and to sell their weaker stocks for the tax advantages. This, of course, will strengthen your portfolio over time.
Other times, deciding when to sell stocks is easy.
When selling stocks is easy
As we age, our investment objectives usually change. A non-dividend-paying speculative growth stock may be suitable for you if you’re 30 with a safe job and high income. But as you near retirement, chances are this stock will no longer fit your investment objectives. At that point you should sell and reinvest the money in a dividend-paying, high-quality company.
When you can no longer fully trust management, it’s best to sell. That’s why we removed ATI Technologies and Royal Group Technologies from our Key stocks list in the past. Billionaire Warren Buffett, for instance, will only buy companies run by trustworthy managers.
When a company changes fundamentally, it may no longer meet your investment objectives. Precision Drilling, for instance, was a great growth stock. Had you bought it when we added it to our list of Key stocks in 1996, you would’ve earned 956 per cent over nine-and-a-half years. But after selling its high-growth assets and turning its Canadian rigs into an income trust, it was no longer a growth stock. So we removed it from our list of Key stocks.
It’s also best to sell companies with excessive debt. The corporate graveyard is full of companies that took on too much debt and failed when they couldn’t service their loans.
The Investment Reporter, MPL Communications Inc.
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