It’s all very well for investors to know when to buy, but what about knowing when it is time to sell.
The time to sell
I once noticed a stock I particularly liked kept going up and down in a kind of corridor. It kept falling to one price and then rose to another. It was just natural oscillation. I reasoned thus: buy when it is at the bottom of that corridor and sell it at the top.
There are two snags with this approach. Firstly, watch out for transactions fees. Buying and selling like that gets expensive. Secondly, you eventually lose out if the share price rises to a new high. And since I only think this approach should be applied to a stock you especially like, sooner or later you would expect it to rise to a new all-time high.
And that brings me to one of the biggest challenges for investors, when to sell.
Warren Buffett has some interesting advice in this respect: “Our favourite holding period is forever” he said.
There is one snag with this. Sure it would be nice if you can do that, but things change. Hold a share forever, but only if you forever like it.
And that takes me to my first rule over the time to sell. Sell when you don’t think you would buy. By that I mean be aware of loss aversion. We all hate losing money. If a share starts falling such that it is worth less than we paid for it, human nature says to stay in there and wait for it to recover. Instead, you should ask yourself one question. “Would I buy this stock if I didn’t already own it?” If you wouldn’t, then I think you have an answer to the question ‘when should I sell this stock?’
I have another rule, don’t sell because you need the cash. Now that is easier said than done. I have had to do precisely that in the past. What I really mean by that is don’t overcommit yourself. Don’t invest such that you are stretching your cash-flow, risking the necessity to sell. Of course, no one can know the future; you might have no choice. But as a rule I would say don’t invest in shares as a way to save for a rainy day — because that could force you to sell.
But there is a broader point. The answer to the question when should I sell, depends on why you are investing.
If you are investing in anticipation of building a nest egg for say 20 years, then you will probably invest in growth stocks. If instead you want an income, you might want to invest in high-dividend stocks. But at some point, the long term investor will change priorities — say, for example, they have been investing for 20+ years, and now they want an income. That might be a good time to switch, to sell growth stocks and buy income stocks.
But don’t sell because you have reached your target date. Make your target date broad, otherwise you might sell the day after a market crash. One way you could sell when your target date is approaching is to sell bit by bit. Maybe sell say five per cent of your growth stocks a month for 20 months. And invest in income stocks in parallel with your selling.
You might also want to set rules in advance. Sell once specific targets are reached, for example.
But let me leave you with one more rule — or saying may be a more appropriate description. Buy when all but the most bullish investors have turned bearish, and sell when all but the most bearish of investors have turned bullish. In other words, sell when all around people are buying.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.