Besides knowing when and what stocks to buy, investors also need to know when is the best time to sell their stocks. However, this can be a tricky task. Even the best portfolio managers may sometimes end up selling their stocks too early or too late. With that in mind, I thought it would be useful to highlight four scenarios when you should consider selling your shares. Scenario #1: When the original reason you bought the stock has changed When we first buy a stock, we usually do it because of certain reasons we believe make it an excellent long-term…
Besides knowing when and what stocks to buy, investors also need to know when is the best time to sell their stocks. However, this can be a tricky task. Even the best portfolio managers may sometimes end up selling their stocks too early or too late.
With that in mind, I thought it would be useful to highlight four scenarios when you should consider selling your shares.
Scenario #1: When the original reason you bought the stock has changed
When we first buy a stock, we usually do it because of certain reasons we believe make it an excellent long-term investment. It could be because the company is operating in a fast-growing industry and had the best technology to eat into its competitor’s market share or that it has a clean balance sheet with a capable management team.
Unfortunately, in the dynamic world of business, things may change suddenly and drastically. A company may change its management, technological innovations may completely disrupt the industry, or even new competitors might enter the fray, eating into the company’s market share.
All of these could mean that the original reasons for buying a stock no longer holds true. If this happens, we need to be willing to make the tough decision to sell.
Scenario #2: You need the money in the next five years
Ideally, we should not be investing the capital that we will need in the near future. Stocks need time to appreciate and can be highly volatile and erratic in the short term.
Therefore, if for some reason, you realise that you will need the money within the next five years, you should take out your capital from the stock market. Invest money that you need for the near term in less volatile assets, like fixed deposit or government bonds, which are safer short-term assets.
Scenario #3: There are better options for your money
The limiting factor for investing in the stock market is not the lack of options, but our limited capital. Therefore, another reason to sell a stock could be when you find a better choice that could make your money work harder for you.
That being said, shifting your investments from one stock to another or one asset class to another comes at a cost. There are transaction fees and commissions that we should be aware of. As such, we should only be selling to reinvest in better options when we have a high conviction that it will result in higher returns.
Scenario #4: To rebalance your portfolio
No matter how well you diversify your portfolio, a single company’s stock can perform so well that it becomes a huge allocation in your portfolio. This can result in concentration risk, whereby any underperformance in that particular stock will result in an overly large movement in your portfolio. If this happens, it may be useful to sell some of that stock to rebalance the portfolio. I prefer that no single investment of mine makes up more than 10% of my portfolio at any point in time.
The Foolish conclusion
Once we have purchased a stock, the best thing to do is give it time to grow. There’s nothing more detrimental to your portfolio than to frequently trade in and out of positions. Selling stocks has to be a rare occurrence that should only happen in one of the above scenarios.
Warren Buffet famously said that his favourite holding period is forever. As Foolish investors, we should be investing for the long-term and only sell when we really need to.
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