When do you sell – the important part of investing that investors forget about

Investors spend hours analysing stocks before they buy. There are hundreds of strategies to follow, and many books on value, growth and income investing strategies on what to buy and when. But what investors easily forget is knowing when to sell a stock is just as important.

There are many reasons to sell a stock, and sometimes those reasons have nothing to do with the stock itself. For instance, selling stocks can be part of an investor’s retirement plan. In another scenario, an investor may plan to leave stock to an heir. In that case, they never sell the stock.

Let’s dive into a few of them…

4 Reasons when to sell a stock

Reason 1: You’re getting close to retirement and need to de-risk.

The more experienced you become as an investor, the better you learn to understand (and tolerate) risk. But, as you near retirement, your ability to absorb high risks, and the consequences they pose, decreases.

Simply put – at 20 you can afford to invest the majority of your cash in penny stocks because you have many more years of income generation ahead of you. You can wait it out for a stock to soar, and if you take a loss, your income can make up for it.

But at 65, your income generating years are past. You cannot afford to risk as much, because a large loss cannot be recovered from, and you will soon need your capital as retirement income. So, even though years of experience teaches you to better tolerate risks, your ability to absorb big losses in your equity portfolios declines with age.

At that life stage, it’s wise to begin building out positions in cash and bonds and reduce your exposure to equities. If this, is you – it’s a smart thing to start by reducing your equity exposures slowly on an annual basis. Start by the time you’re 60, and drop equity as a % of your entire investments by smaller amounts annually rather than simply selling out half your shares all at once and investing everything in bonds at the same time.

Reason 2: When prices have risen dramatically or overshot your target

When RCL Foods shot up to R16 a share from 860c in just 9 months, I told Red Hot Penny Shares investors to sell at R15. A 74% increase in under a year is definitely a dramatic rise in price. But the call to sell the share wasn’t an arbitrary decision based solely on the fact that the share price was high… It was based on the financials of the company.

You see, it had released a trading statement and even though earnings had increased significantly and its PE ratio was low, the results also showed a key input cost in the poultry business, the maize price had also dramatically increased, at the same time fuel prices were going up, and interest rates would increase, meaning pressure on consumers that buy RCL’s products.

This signalled further upside in the stock was unlikely, and it was more likely to see a cyclical downtrend. So, Red Hot Penny Shares investors sold out of their position. And it so happened, the stock went into a downtrend shortly thereafter.

For stocks that have risen 100% or more and we see further growth, we can employ a different tactic. Here we would sell HALF of our position. That takes all the risk off the table by returning our initial capital outlay back to us. But you retain a holding off the share if there’s further upside potential.

Reason 3: Tax considerations

Sometimes holding on to a winner for a bit longer could mean the tax you pay on it changes from income tax to lower capital gains tax. Generally – holding a stock more than 3 years means SARS will tax it as capital gains, compared to income tax for shorter holding periods.

Similarly – selling a loser just before tax year-end could benefit you.

Tax alone isn’t the only criteria to make selling decisions on – but it should play a role. So, you need to consider your tax situation. If you’ve already sold a number of winners for the year – don’t sell another winner on 24 February. Rather wait a week for the new tax year and sell it then. That way you don’t become liable for the taxes immediately, and in the case of capital gains tax, you get to use the next years exclusion as well.

Alternatively, if you’ve sold a bunch of winners, and you are holding on to a big loser it might just be worth selling it before tax year end to limit your tax liability.

Reason 4: Fundamental changes – or the realisation you made a mistake

Most experienced investors may have encountered this situation at some point. You’ve watched this stock make phenomenal gains on a daily basis, so you finally decide to suspend your disbelief and recklessly put in a sizable buy order for the stock. But as soon as you do so, you realize that you’ve made a mistake. The best course of action in this case is to sell the stock, even if it means taking a small loss on the trade. And to avoid making the same mistake in the future, resist the temptation to chase hot stocks that are running on fumes, as they may burn you financially.

Similarly, you might have bought into a stock with great growth potential. Then something unexpected happens, and the business case for the investment changes. Or you simply missed an important warning sign as to why you shouldn’t have bought the stock in the first place. If that’s the case – rather sell than hold on with only hope to back, you up.

Reason 5: Rival companies could signal a fundamental shift

Let’s say you are invested in a cement producer. The company’s done well, and the industry was looking up when you invested. Then, one of the producer’s rivals’ releases results. They are much worse than expected. The company states that in large the bad results are due to increased competition and dumping of cheap imported cement in the local market.

This should be a big warning sign. Especially because it indicates the whole industry is likely in for a beating. Often, the problems affecting a specific sector may be highlighted when a bellwether company in that sector reports an earnings miss. If you own stock of a company in that sector, consider selling it unless you are quite confident your stock will not be affected by the sector’s woes.

Selling an investment is like buying one—you must make sure it is in line with your investing and financial goals. Also, it’s important to understand your risk tolerance and time horizon.

If you need the money in the next six months or year, then you shouldn’t invest in equities, much less risky equities. The same goes for if you cannot risk losing any capital. But always remember – if you don’t take a risk, you cannot expect outsized returns!