Stock Starter Series, Part 4: When to Sell a Stock

Welcome to Part 4 of a 5-part series for the brand-new stock investor – or the person still thinking about it! My goal in this series is to try to simplify how to get started in this most exciting financial journey. If you’re just jumping in at this post, you won’t get a whole lot out of this series unless you go back and start with the first post.

In the last post, I gave some (hopefully) very practical tips on how to go about buying your first stock, but there comes a time when a person eventually wants or needs to sell a stock.

So let’s get right to it: when should you sell a stock?

A few years back during this blog’s infancy, I addressed this question in posts like this one. However, since this series is geared toward newbie/wannabe stock investors and since some of my approaches to selling stocks have changed, I’m going to re-address this potentially very stressful aspect of stock investing.

Never

Here’s Warren Buffett’s take on how long his holding company, Berkshire Hathaway, prefers to own stock in a company:

“Our favorite holding period is forever.”

Which is to imply that a long-term investor should never sell a stock unless one absolutely has to.

David Gardner started up The Motley Fool in the early 1990’s with his brother Tom as a friendly way to see whose monthly stock picks would do better over time.  David is perhaps most famous for choosing Amazon as a stock pick when most others thought he was, well, a fool.  Now that his first AMZN recommendation is up over 11,000 percent, the only person laughing at him any more is admittedly himself!  (FYI, his first Netflix NFLX recommendation in 2004 is currently up over 20,000 percent.)

Anyhow, now that you know a bit about David, you might also find it interesting to learn how he’s openly confessed that, although he may be known for some of the most successful stock picks in recent history, he’s absolutely lousy at selling stocks!  However, this has obviously worked to his advantage not just with the two companies above, but with his several other multi-thousand-percent recommendations.

So the point (in case you’ve somehow missed it) is that you should hold any stock that you buy for as long as absolutely possible.  Why?  Well, as the most successful investors in history like these gentlemen might argue, ‘Why not?’  And I might add, who knows when you might need a large sum of money?

In case of emergency

For most people, it has proven unrealistic to hold onto stocks for as long as the likes of Warren Buffett and the Gardner brothers.  They might have multi-millions (or billions) to spare, but for most of us, life happens.  Medical emergencies arise.  Work injuries happen or jobs suddenly disappear.  An illness or disease impacts you or a family member.  A child goes off to college or gets married.  Retirement comes along.  Long-term care might be needed for you or a family member.  The list goes on.

In the case of any of the above, wouldn’t it be nice to have invested even just $1,000 in Amazon or Netflix and gotten even a 1,000% return?  I don’t know about you, but the $9,000 return in this case might come in handy in a pinch, no?

Instead, most people don’t have a savings account let alone even one stock investment that has gone to the moon.  So they rely on the government or getting into debt or a relative or the lottery or some sort of generous act to bail them out of a financial emergency or nightmare instead of developing good financial sense, like saving and then investing a mere ten percent of their take-home income into stocks.

Maybe they’ve spent $1,000 on Amazon products or a Netflix subscription – or some other company’s products or services that they and many others love – without realizing that maybe it would also be a good idea to scrounge up enough to buy $1,000 worth of their stock?

I could go on A LOT about how the vast majority of people choose to waste – er, spend – their money instead of preparing for life’s inevitable emergencies.  But if you’ve read this far and still have excuses about why you don’t want to consider investing in stocks, then you can’t say that you didn’t have enough evidence about their potential to go on.

In case of non-emergency

The best time to sell a stock is when you don’t need to, but when you can sell at the price you want to.  You can sell with the satisfaction of knowing that you made maybe thousands or tens of thousands or even hundreds of thousands of dollars more than if you had been forced to sell it for an emergency.

One great example would be when you reach an age where you simply don’t want to work any more; it’s just getting too hard on your body or mind.  If most people could fast-forward to age 65 and realize that the typical government pension pays them only about two-thirds of what they were struggling to get by on while still working, then maybe a lot more people would be serious about squirreling away a measly ten percent of their net income and investing it?

There are other situations when it’s just nice to be able to dip into a big nest egg in order to bless others, like your children or grandchildren who might need a leg-up with certain things.  Some successful investors even get their kids or grandkids into investing by buying their first stock for them, then teaching them how to manage the tough part:  what to do once you own a stock!

When you have a bunch of money to spare, it’s a lot of fun to get imaginative about how to bless other people instead of spending everything on just yourself!

Okay, so far I haven’t given any practical strategies about when to sell a stock, some numbers to go on.  Here are a few.

Sell after a certain percentage gain

Shorter-term investors set a percentage rule whereby they sell either all or half of the shares in a stock once the return reaches a certain percentage.  A common rule is to sell after a 20% return or 50% or 100%.

Sometimes I only sell half the shares of a stock once the price has doubled (100% return) instead of all the shares.  I do this if I’m a bit torn between whether or not I think the stock still has potential.  I got this idea several years ago from Robert Kiyosaki.  By doing this, I’m taking my original investment amount ‘off the table’ and investing it in another stock that hopefully does just as well, if not better.  If the remaining shares still go up, great – I didn’t miss out because I didn’t sell all of them.  If they don’t do so well, I was still able to diversify by turning one stock into two.  Anyhow, doing this is more for comfort than anything and it’s just one strategy to preserve gains plus diversify.

If a stock has doubled and I’m still very confident in its long-term outlook, then I’ll let it run.  Until I became a Stock Advisor subscriber, I never had the guts to try this out!  However, once I learned how it had worked miracles for the likes of Warren Buffett and long-term Berkshire Hathaway shareholders plus also the Gardner brothers, then I had the confidence to try this myself.  What I’ve shared during this series of posts about having more of my stocks multiplying in value is the result of this tactic.

Sell after a certain percentage loss

One of the hardest things that I and other stock investors struggle with is selling once a stock’s price starts to get uncomfortably low.  There are a couple of key reasons for this that I’ve experienced and also learned about others:

  • Pride.  We don’t want to think that we made a mistake and so we hold on with the hope that the price will turn around.
  • Emotions.  We might be too emotionally attached to the company for reasons like how well it has performed in the past or because we still like and/or use the products or services it provides.

The Cabot Wealth Network, which has been around since the 1970’s, advises its subscribers to “cut losses short” – no questions asked.  During the time that I was a subscriber of theirs a few years back, they suggested ditching a stock once it had fallen 20 percent below what you bought it for.  A rule like this is good for forcing you to take action when your pride or emotions don’t want you to.

Some people might have a lower tolerance, like only 15 percent, but in any case, YOU NEED TO COME UP WITH A RULE OR PLAN for getting out of a stock that starts losing too much of its value.

The Warren Buffetts and Gardner brothers of the investing world argue otherwise.  They think that you should never sell even if things get really bad.  However, I know that they, too, have sold stocks that have turned into stinkers, BUT ONLY if their original investing thesis has changed.  Allow me to explain.

If the general market is down due to socio-economic and other non-company related factors and many stocks have taken a hit of 20 percent or more, then it makes sense to hold on until the emotions of fear that have driven the market down go away and the market rebounds.

However, if a company relied on 30 percent of its revenue from one customer and that customer has switched to a different supplier, then the stock is likely to take a big hit once the news comes out.  In this case, a company-related factor is driving down the stock price.  This is now a company different in nature than when you first bought shares in its stock.  In this case, it is entirely reasonable to sell before the loss gets too large.  The alternative is to not sell and take the super long-term approach of hoping for an eventual price rebound, of hoping that that lost revenue is replaced, but this only makes sense if this company makes up a small portion of your portfolio, say, less than five percent.

The Final Word

Again, there are no hard and fast rules about when to sell a stock, just as there are none for when to buy a stock.  The point is, as I’ve mentioned already, TO COME UP WITH A PLAN AND TO STICK WITH THAT PLAN.  A number of people come up with some sort of plan, but then they abandon it once pride gets threatened or emotions get too intense.  Again, I speak from past experience.

——————–

Speaking of plans, the original one for this Stock Starter Series was to have a Part 5:  Investing for the Long Term.  However, these first four parts have given plenty of examples of how crucial it is to develop a long-term mindset as a stock investor.  Reading articles on The Motley Fool’s free site at http://www.fool.com or preferably one of their recommendation services like Stock Advisor – which I’ve mentioned several times already, but for good reason! – will help you develop this mindset, assuming you dive into them and take them seriously.

I had also planned to have a bonus post called Stock Investing Myths, but looking back through the archives, I already explored some in this post and I have frankly nothing to add.

Instead, I have written Part 5:  Final Insights, where I wrap up some of the thoughts that I’ve presented thus far.  One last thing:  be sure to click the Follow button near the top of this page.

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