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When you should sell your stocks — and when you should not

There’s been a whole lot of selling going on, says this Canadian advisory, but how many investors really know what and when to sell?

It may seem like pouring fuel on the fire to talk about selling with so much of it going on.

But could there be a better time to talk about it? How much of the orgy of selling we’ve seen lately was done with a clear head and a cool eye?

Probably a very small percentage, if the truth were known. And when you think about how much money is thrown away by selling the wrong thing at the wrong time — well, it’s best not to think about it.

One of Canada’s oldest advisories, The Investment Reporter, puts it flatly: “Selling is a skill that nobody masters.”

Still, the advisory is ready to help investors hone their command of a discipline that seems to be more puzzling than quantum mechanics.

The lesson begins by pointing out three reasons why you should sell. It ends by pointing out when you should absolutely not sell.

Profit when you buy

This advisory starts out by quoting a maxim of the real estate industry: “You make your profit when you buy.”

That’s easily converted into investment terms. If you’ve planned and purchased your portfolio carefully, you don’t have to worry so much about whether or not you have good selling skills. It will carry you a long way through good times and not-so-good times.

But even so, there are times when it is right to sell. And as mentioned above, three reasons to do so.

Take the money and run

The first is the “take profits” sell. “Sometimes,” says the advisory, “stocks become much too costly and are inevitably headed for a fall. That’s why another name for this is the ‘take-the-money-and-run’ sell.”

Admittedly, that hasn’t been a problem for a lot of stocks recently. But that doesn’t make it any less important for investors to know the ropes.

Costliness can be a worry when a stock becomes the market’s “darling.” A case in point: the late (more or less), lamented Nortel Networks. Back when that stock was riding high, The Investment Reporter stepped in with a warning.

“It’s quite possible that Nortel Networks may weigh too heavily on your portfolio. In this case, you might consider taking some profits from this manufacturing company.” And, the advisory reminds its readers, it followed up with this counsel: “Our advice is to take profits if you’re a conservative investor.”

As we know, Nortel wouldn’t take up much room in anybody’s portfolio nowadays.

But that’s not the only way stocks get overpriced.

The tide that lifts all boats

A stock may leap on a takeover bid, or because short-sellers have panicked and rushed to buy back shares they borrowed and sold.

A stock may also rise well beyond its true worth with the proverbial tide that lifts all boats (think many high-tech stocks a decade ago). Or it may just rise slowly but surely to the point where it’s overpriced.

If you feel that your stock is getting overpriced, but you’re not quite ready to give up on it, you can of course keep some shares and take profits on the rest.

The second and third reasons to sell have to do with the nature of life and the character of your portfolio.

All your eggs in one basket

The second type is the “getting-out-because-you-have-to” sell. Your circumstances have changed. You’re older, perhaps, or you’ve changed jobs, and “you need to sell stocks for reasons that have nothing to do with fundamentals and may, in fact, run counter to them.”

In this case, sell gradually, says the advisory, over a period of months or even years. And don’t wait until you absolutely have to sell — you may wind up selling when the market is at a low point.

The third sell is the “I’ve-got-all my-eggs-in-one-basket” type. Mr. Andrew Carnegie, the billionaire philanthropist, told people to put all their eggs in one basket, and watch it very carefully.

“But as the owner of U.S. Steel, Mr. Carnegie had access to the kind of insider information individual investors lack,” says the advisory. So while that strategy may have suited him, it’s probably not so good for you.

So spread things out. You may, for example, own lots of shares in both Bombardier Inc., (TSX-BBD.B) and CAE Inc. (TSX-CAE). But both depend on the very cyclical aviation industry. So you may wish to sell one or the other, or some of both, says the advisory.

Going broke taking profits

There is also a time not to sell. “One common mistake,” says The Investment Reporter, “is to sell to nail down a modest profit when the best is yet to come.”

Many brokers claim that you no one ever went broke taking profits. Not so fast, says the advisory. If you sell a stock simply because it has gone up, “you’ll never have a big winner — and you need a few big winners to cover your inevitable losses.”

Or, as one very successful investor remarked dryly about the secret of his success: “I was smart enough to buy Canadian Tire at $0.50, and too stupid to sell when it hit $2.00.”

Note that nowhere above does it say if the market’s going down — sell! You bought the stocks you own for a good reason. If you can go broke taking profits, you can go a lot broker taking losses under duress. In a crisis, look calmly at each of your investments before you act.

While nobody can perfectly master the art of the sell, as this advisory acknowledges, nobody is better equipped to deal with the markets than those who understand the pitfalls and profits of selling. That goes for the good times — and even more for the bad.