I'd like to think of myself as a pretty well-educated investor. My family's finances are in order, we live well below our means, and I spend the better part of every week focused on stocks and finance.
And yet, even that doesn't make me immune from one of the biggest mistakes investors can make: not knowing how or when to sell a stock. As you'll see below, a single decision made back in 2012 has already cost my family nearly $50,000.
The experience has taught me that knowing when to sell a stock is the most underappreciated skill in investing. Part art, part science, nothing is more consequential to your long-term capital gains than knowing if it's time to click the "sell" button.
Case in point: In March 2012, my wife and I made the biggest mistake of our investing lives. At the time, we owned a split-adjusted 154 shares of Netflix. Though the stock had fallen, we were sitting on huge gains and decided to sell. "How much higher could the stock go, anyway?" we said to ourselves to justify the move.
At the time, shares were trading for (a split-adjusted) $9 per share. In March 2018, they hovered at $330. The cost of this single decision: almost $50,000!
That's an expensive price to pay for an investing lesson. But you can avoid this fate by learning from my mistakes. After years of pondering the question, I've decided that there are only six times when it makes sense to sell a stock. In order of importance, they are:
Let's dig deeper into each.
In the rush of adrenaline that comes with investing, it's often easy to forget the most important question: "Why do we invest in the first place?"
There are as many answers to this question as there are participants in the marketplace. But I think Motley Fool co-founder David Gardner did a beautiful job of summing up why we invest in a 2017 podcast:
The bottom line in what David is saying is that investing is a tool to help make our lives better.
If you are losing sleep over your investments -- not able to focus on time with your partner or your children or suffering from stomach pains whenever a particular stock drops -- then what is supposed to be a tool to make life better is doing the exact opposite.
There's an important reality that every investor needs to come to terms with: While the market goes up more than it goes down, when the market does fall, it can often fall quickly. Consider some of the biggest drops over the past 50 years.
| Index | Time Frame | Total Losses |
|---|
| Nasdaq Composite | March 2000-September 2002 | 76% |
| S&P 500 | October 2007-March 2009 | 57% |
| Nasdaq Composite | December 2007-March 2009 | 53% |
| S&P 500 | August 2000-September 2002 | 47% |
| Dow Jones Industrial | January 1973-December 1974 | 42% |
| Dow Jones Industrial | August 1987-October 1987 | 35% |
Data source: YCharts. Note: Not an all-inclusive list.
While it may have been the smallest of the drops listed, consider for a moment what the 1987 fiasco must have been like for investors. Whereas the other drops took months or years, over one-third of investors' value disappeared in just 36 trading days. The market fell over 20% on a single day: Black Monday, Oct.19, 1987.
If you own a stock that displays this kind of volatility and you can't stomach it, it's simply not worth owning anything that gives you such fits. And once you're done selling, you need to follow up by taking stock of your own emotional intelligence and make future decisions accordingly.
Now imagine this scenario: You were planning on buying a new house because you're expecting a child in the next few months. But the money you were going to use for a down payment was tied up in the market when it had one of the aforementioned drops. All of a sudden, you have to pull out -- if you can afford it -- a much larger percentage of your nest egg to meet your growing family's needs.
The same could be said for any other major life events, like a retirement on the horizon, or paying for college. If you know a major expense is coming in the next three years, the money to cover it should not be in stocks. It should -- instead -- be in safer short-term investments, like a money market account. If you need to sell some stocks to ensure you can cover these expenses, you should do it.
Another reason why you should sell stocks to shore up any needs you might have in the short-to-medium term is because it will give you a cushion when the market does eventually fall, and help prevent you from selling at the bottom.
In a recent interview with former hedge fund manager, professor, and best-selling author Nassim Nicholas Taleb, he explained why drastic market drops can be terrible for your long-term wealth:
As an investor you need to think about it in these terms: No investor knows what's going to happen to him or her in the future.
If you need to sell stocks to give yourself a cushion, do it now and on your own terms. Otherwise, you'll be forced to sell everything at the worst possible moment.
Now that we've covered the macro reasons to sell a stock, let's focus on much more specific cases.
Before you ever buy a stock, one of the best things you can do is start an investing journal. In this journal, write down two very simple things to help you make better decisions: exactly why you think a stock is a good "buy", and what would have to happen to make you sell a stock. The former is referred to as an "investment thesis" while the latter defines your "exit strategy."
Writing these things down while you have a level head is a great way to protect yourself from making emotional investing decisions.
Critically, your investing thesis and exit strategy should have everything to do with the performance of the underlying company -- and very little to do with the performance of the stock itself.
As Benjamin Graham -- the father of value investing and mentor to Warren Buffett -- once said: "In the short run, the market is like a voting machine -- tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine -- assessing the substance of a company."
To be a successful investor, you need to ignore the noise of the short-term stock market moves, and focus on the long-term signal provided by "the substance of a company." Writing down your reasons for buying -- or potentially selling -- will make it much easier for you to part ways with a stock once your original thesis no longer holds water.
Of all the reasons to sell a stock, this is by far the murkiest. In fact, it's best to avoid using this stock-selling justification if at all possible. If you have a regular schedule of investing a certain portion of your earnings every month on a single stock idea, you can skip this.
However, from time to time, life can get in the way. For instance, my wife and I regularly devoted 20% of our earnings to the stock market. When our children were born, however, things changed: We bought a house, she stayed at home, and our expenses went up. We simply didn't have as much to invest.
But that didn't stop me from researching companies to invest in. When great ideas came along -- but I didn't have dry powder to invest -- I had to weigh how good an investment each of my positions was. If, after careful evaluation and sleeping on it, I decided one stock was a better bet than another, I would sell the latter to buy the former.
And it goes beyond stocks, too. As we already covered, sometimes you need to anticipate changes in your life -- like paying for college or preparing for retirement. When my daughter reaches 15 years of age, for instance, I'm going to start moving a portion of her investments into CDs or money markets. While the returns will likely be lower, so too will the chances of us losing a large sum of money. The same would apply to people approaching retirement. Slowly, a portion of one's nest egg should be moved into less volatile investments -- CDs, money markets, and bonds.
There are times when selling stocks can help you lower your taxes. This is often referred to as tax loss harvesting.
The basics are pretty simple and only apply to your non-tax-advantaged (i.e. non-IRA or retirement) accounts. When you sell a stock that you lose money on, this can help offset any taxes you might owe for capital gains. By selling losing investments, you can cancel out capital gains you might experience and up to $3,000 in earnings as well.
There are, however, a few tax caveats worth mentioning. First and foremost, if you are selling a stock of a company that you have serious conviction in (i.e. that you strongly believe will be a solid performer), you must wait at least 30 days before repurchasing the stock if you want to get the full tax benefit. You run the risk, then, of missing the stock making gains during the time frame you don't own it.
Sometimes, investors mitigate these risks by selling one losing investment and then buying shares of a similar company immediately thereafter. In some industries -- say, energy, where you are dealing with two oil companies -- this makes sense. In others -- say, social media, where there are only a few dominant players -- it doesn't.
You need to plan your moves wisely and consult your tax professional to get the best advice.
Finally, it's wise to figure out what the maximum percentage of your portfolio you are comfortable having devoted to a single stock. Even if you spread your bets around evenly, a single company's stock can perform so well that it becomes an enormous allocation. That can also make you lose sleep.
This is something I know well: Amazon has easily been my family's best investment. At one point, however, it accounted for 25% of our portfolio. I wasn't comfortable with it eclipsing the 20% mark. As a result, I've had to periodically sell shares of the company to make us more "balanced."
Most professionals would counsel that even my 20% allocation is a bit risky -- all it would take is some unforeseen event and my family could lose a significant portion of our nest egg, for instance. In fact, many believe that you should rebalance your portfolio according to the different industries and company sizes that it contains every year.
At the end of the day, however, it's up to each individual investor to weigh and acknowledge the risks and rewards that come with the allocations in their portfolio.
Once you make the decision to buy a stock, there's nothing more hazardous to your wealth than frequently trading in and out of positions. Selling stock should be a rare occurrence, and only if you fall under one of these six circumstances.
Otherwise, stick to a regular investing schedule, check your portfolio quarterly, and go on enjoying your life!
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Amazon and Netflix. The Motley Fool owns shares of and recommends Amazon and Netflix. The Motley Fool has a disclosure policy.
