Deciding when to sell a stock — if and how much — requires nearly as much planning as determining when to buy it.
Many investors make selling decisions solely based on price movements. But a stock that’s fallen in value may still be a perfectly sensible investment to hold. Conversely, selling a stock that has risen and delivered a tidy profit might be prudent if it has hit a price target or grown out of proportion in your portfolio.
Establishing guidelines upfront for what would make you consider selling — an investing prenup, if you will — removes the stress and potential for errors. So will asking yourself these seven questions.
1. Is the company suffering from a setback?
The problem with having nonstop access to market data and news is that it’s hard not to look. All. The. Time.
Even knowing that stocks can be volatile over short periods doesn’t make investors immune to emotional triggers that lead to hitting the eject button on an investment too soon.
If recent or sudden price movements are causing you to give a stock some side eye, get some perspective. Compare the company’s returns to its benchmark and its peers over the same time period. A sector-specific exchange-traded fund can serve as a benchmark.
Context can help you discern whether the lagging performance signals trouble under the hood of your specific stock or if you’re witnessing a byproduct of overall market movement or an overreaction to news.
» Prone to emotional investing? You might be a good candidate for a robo-advisor.
2. Have the fundamentals changed?
Companies and the markets in which they operate are constantly evolving. A business’s ability to adapt to change may dictate whether it makes sense for you to sit tight or sell.
Some challenges are harder to overcome than others. A strong competitor that starts stealing significant market share or a firm whose accounting practices come under question may be valid reasons to sell shares.
Other developments may be worth sticking around to see how they play out. A management shakeup may not mean a wholesale change in the way the business will be run. A delayed product launch or a few bad quarters don’t always signal total defeat.
3. Is there a better place for your money?
Billionaire investor Warren Buffett says his favorite holding period is forever. But that’s not always realistic for the average investor with a finite amount of money to invest.
There are opportunity costs of staying invested in a stock instead of selling it to free up cash for other purposes. The opportunity could be another investment, such as a different stock you’ve been eying with better long-term prospects than the one you own.
Sometimes the “better place” is cash because you need the money for an upcoming expense such as retirement income or college tuition. Selling stocks to satisfy cash needs is a wise move to avoid overexposure to the market’s short-term volatility, putting your money at risk. But you want to avoid raiding long-term funds you’ll need in the future if you have other options for satisfying your short-term cash needs.
4. Has the stock thrown your portfolio out of balance?
Ideally, you’ve spread your money across the categories of investments that align with your goals, time horizon and risk tolerance. Over time that mix will shift as some investments outgrow others, making it necessary to bring your portfolio back in line with your original asset allocation plan.
Two options to even the scales are to buy more of the stocks that have fallen behind and to sell shares of the outperformers. (Here’s how to deploy these portfolio rebalancing strategies.) Although selling winners for the sake of rebalancing may not feel good, it’s all about controlling for risk.
5. Will selling get you a tax break?
Congratulations — your investment went up! Before you spend all the proceeds remember: Selling a stock that has increased in value in a taxable brokerage account can trigger a tax bill from the IRS. The damage depends on whether you’ve held the investment more than one year. If so, you qualify for the lower long-term capital gains tax rates. If not, higher short-term capital gains rates apply.
But there’s also a workaround if you have any stocks that lost money. Selling the losers can lower your taxes in a maneuver called tax-loss harvesting.
You can use the amount of money you lose on an investment — up to $3,000 a year — to offset any taxable investment gains. You could even use it to reduce your ordinary income tax tab. That would provide a bit of financial and emotional salve to selling because an investment didn’t work out.
6. Will you repurchase the stock after selling?
When you sell a stock at a loss and buy it back, or buy a similar investment, within a short time, it’s called a “wash sale.” What gets washed is your ability to use that capital loss to offset taxes on investment gains.
The wash sale rule kicks in if you buy the same or a nearly identical stock either 30 days before or 30 days after selling the stock at a loss.
If you are a full-time stock trader in the eyes of the IRS, you can qualify for a wash-sale rule exemption as well as other active trader tax breaks.
7. How will you make your exit?
Timing a sale perfectly is nearly impossible. No investor can reliably choose the exact moment when a stock is at its tippy-top high or lowest of lows. Running for the exit could cause you to miss out on additional gains or lock in avoidable losses.
One way to smooth the transition is to employ the same trick investors use to build their holdings in a particular stock: dollar-cost averaging. But instead of investing money over weeks or months to build a position at different prices — which evens out the average price an investor pays for the stock — you sell shares at different periods over time.
Selling doesn’t have to be all or nothing. If you think the stock is still worth owning but you want to reduce your exposure, hold on to some of your shares.
Asked all these questions and think it’s time to sell? Dive into the procedure with this piece on how to sell a stock.