Some readers may have seen the article published in Fairfax media yesterday titled: "Know when to sell your shares."
This is an important topic that doesn't get enough attention, even among Foolish investors who usually aim to 'buy and hold' over the long term.
(Foolish analyst Mike King wrote his own take on the topic yesterday, and created a helpful Google Sheet investors can use before buying or selling).
At the conclusion of the Fairfax article was a summary of 8 tips investors can use to make selling easier. Not all of them are as useful as they are touted to be, however:
- Reduce the size of individual stocks if they take up more than 5% of your portfolio
This is an arbitrary and pointless rule. Presumably the intent is to ensure diversification and/or minimise your exposure to any one sector, but it will be of no use if you own 20 mining services companies. Investors with small portfolios or those just starting will likely have more than 5% of their portfolio in each stock due to minimum trade sizes.
Further, reducing the size of each position splits your risk, but also minimises the effects of your winners. I personally hold more of the companies I feel are most likely to win, with my single largest holding being Carsales.Com Limited (ASX: CAR) at 8.14%, followed by Collection House Limited (ASX: CLH) at 8.06%.
Instead: Make your riskier stocks a smaller part of your portfolio, while your better performers and likely winners occupy more space. Don't put all your eggs in one sector basket – for instance if you own pathology company Sonic Healthcare Limited (ASX: SHL), you probably don't need to buy Primary Health Care Limited (ASX: PRY), which also makes most of its money in pathology.
2. Sell any stock if the market price is more than 25% higher than its intrinsic value.
What is intrinsic value? Welllll that's a whole other story but it's essentially a value estimate made by an analyst or company.
Selling a stock when it becomes overpriced makes sense, but automatically selling because a stock reaches a certain price makes none as it overlooks the potential for errors in the intrinsic valuation. Additionally, stocks can outperform and expectations can build further, like Blackmores Limited (ASX: BKL), which hit $157 just recently – definitely more than 25% above intrinsic value!
Furthermore, investors with a ten-year time frame (owning good companies) are likely to see substantially higher prices in ten years' time, meaning they could be selling for short term gains and missing long-term ones. Intrinsic values often focuses on a shorter timeframe.
Instead: Consider selling some of a holding if the market price is substantially higher than its intrinsic value. You can reinvest the profits elsewhere, or back into the stock if its price falls.
3. If you can wait 12 months to take advantage of Capital Gains Tax discounts, do so
This is a no-brainer. Investors receive a 50% discount on capital gains tax (CGT) if they hold a stock longer than 12 months. Generally speaking, it takes at least that long to see a measurable improvement in performance (and price), so selling sooner rarely makes sense.
4. If you can sell in a tax-free environment (pension phase in Self-Managed Super Fund), do so.
"…If anybody in this country doesn't minimize their tax they want their heads read because as a government I can tell you you're not spending it that well that we should be donating extra." That was the late Mr Kerry Packer on the topic of donations to the government; if you're trying to retire wealthier, this is another no-brainer.
5. If you have bought a stock expecting price increases and this does not eventuate, re-assess whether it has a place in your portfolio.
Generally speaking, all investors should expect price increases when they buy stocks as this compensates for the risk taken by investing in the stock market. A company that is not performing should not be kept in your portfolio, although fixating on price is silly.
I bought Coca-Cola Amatil Ltd (ASX: CCL) because it is a great company and appears undervalued, but 18 months later I'm still sitting on a paper loss. However, the business performance is improving, and price follows performance (eventually).
Instead: Forget about price! If you bought a stock expecting its price to rise as a result of good performance and the performance does not eventuate, re-assess whether it has a place in your portfolio.
6. If you have bought a stock for the income and the income does not eventuate, sell the stock.
This is a very sound recommendation as it is rare for an Australian company to cancel or cut its dividend. No dividend generally indicates a struggling business or stressed balance sheet. Also, learn to look beyond your brokerage website's dividend yield (which is usually last year's dividend) before buying an income stock.
Metcash Limited (ASX: MTS) and Origin Energy Ltd (ASX: ORG) both appear to have high yields on popular online brokers, despite the fact that Metcash cancelled and Origin reduced its dividend in response to business pressures.
7. Set a stop-loss for all stocks – say 15% or 20% – and exit the stock if the loss is reached. Exit dispassionately and clinically.
Stop-losses are a real 'horses for courses' approach if ever there was one – and have been a hotly contested topic among members on the Foolish forums. I personally do not use them as evidence shows that the market experiences 10%, 15%, and 20% dips fairly regularly and few of those indicate a financial crisis – in fact, most of the losses are recovered relatively quickly.
Selling out could see you lose the opportunity to buy back in (and lose 15%-20% of your capital). However, if capital preservation is a priority then stop-losses could have a place in your portfolio.
Instead: Just don't use stop-losses because someone else told you to. Learn what they are and how they work, and try them out on a small stock before deciding to apply them to the rest of your portfolio.
8. Know what you are going to do with the proceeds before you sell.
This is a great tip – don't sell your long term investments for short-term depreciating assets like a car or a TV! Having a goal for the proceeds, even if it is just to 'hold more cash' will help keep your wealth on an even keel over the long term.
That was the 8 tips from the experts, though given the high emphasis on selling it seems appropriate to include a bonus tip:
9. Remember 'frictional' costs
Each buy and sell order costs a percentage of your wealth (in fees), and can become quite onerous if you have a small portfolio. Additionally, the more you buy and sell, the greater your chances of getting it wrong. Fund manager Peter Lynch once said 'If you're good in this business, you're right six times out of ten." Would you trade less if you knew that you had a 40% chance of being wrong?
Food for thought.
