5 Questions: When to Sell

The Question of When to Sell Isn’t So Simple
There are any number of things to consider as markets keep rising
Bloomberg, October 30, 2017

 

 

 

 

The question of when to sell is perhaps the most overlooked and under-appreciated problem in finance. It’s worth bringing this up now as markets keep rising. It’s clearly on the mind of more than one investor.

For most of history, Wall Street has been much more concerned with getting you to buy, thus generating returns for you and business for itself. Whether it is an individual stock or bond, mutual fund or commodity, the sell question gets short shrift.

A quick review of the literature shows a dearth of advice on selling. Other than Justin Mamis’s, “When to Sell: Inside Strategies for Stock-Market Profits,” there are not a lot of well-regarded books on the subject. There are books on short-selling, as well as tomes on timing the markets. Every technical analysis or book on market cycles contains sections on breakdowns and sell signals. However, what we refer to here is the broad-based process of how and when to reduce the equity exposure of any portfolio.

It seems like it should be a simple question, but it isn’t. Actually, it’s a loaded query that raises more questions than it answers. The range of sell decisions varies from the algorithmically derived nano-second high-frequency trading, which leads to selling at the first tick down, to Warren Buffett’s approach, which is to buy stocks at such attractive prices that you never have to sell.

For everyone else — those who live in between these two extremes — exploring the question might help you figure out your own “sell” decision-making. Let’s walk through some related questions:

No. 1. What is the basis for making a “sell” call? Most of the time, when I ask a client or investor why they want to sell, I get a parade of horribles that makes them nervous: Nuclear war with North Korea, valuation, recession, earnings, Trump — the list has no end.

In other words, emotions are providing the basis for the sell decision. You know intellectually that’s a terrible strategy. The headline news is always awful; all of those things mentioned above are and have been legitimate concerns for some time — and as those issues recede as a source of anxiety, new ones replace them. Experience teaches us that most of the news is old, and is already reflected in stock prices and is not a credible reason to sell.

No. 2. What if you’re wrong? This is the obvious concern — you sell, and the market keeps powering higher. Traders have all sorts of ways to reverse an error, but the average investor does not. My advice is to always have a line in the sand — where you recognize and admit your error, then reverse your trade decision. Too few people are willing to admit a mistake and correct for it. It bruises the ego, and requires self-reflection to understand where their beliefs went awry.

Most people do not know how to be wrong. That’s an issue we will explore further in a future discussion.

No. 3. What if you’re right? Surprisingly, this the more challenging question. Assume you are correct in your sell decision, and the market falters.

Now what? At what level do you re-enter the market? How do you get back in? Let’s say you moved to cash and bonds because you think that a bear market is coming, and stocks will fall 30 percent. What do you do when markets are down 15 percent? Or 20 percent? Or 25 percent? What happens if stocks never make it to your downside target? What do you do?

The permutations are many; the chances for getting it right but still failing are significant.

No. 4. Do you have discipline? If you have a sell plan and a strategy for implementing it, can you stick with it? Having a template for as many possible outcomes as possible is only your first step. Managing yourself during this period is the bigger challenge.

When the market is not going your way, it is easy to second guess yourself, your models and your strategy. It is very easy to overrule for all the wrong reasons what might be a winning approach. Even worse, we have all seen people be right, then double down inappropriately. Of the people who got the 2008-09 collapse right, recall how many snatched defeat from the jaws of victory, declaring that the Dow Jones Industrial Average would fall to 5,000 or even 3,000. (Just for the record, the low close for the Dow was 6,547 on March 9, 2009.)

No. 5. What is the cost-benefit analysis? Finally, there are the issues not just of the probabilities, but the costs and taxes.

If you are selling longer-term holdings, then you have capital gains tax to deal with. If you are in the highest tax bracket, it’s 20 percent; below that it’s 15 percent (or in some cases, zero).

To make it worthwhile to sell to avoid a 30 percent decline, you must recognize that you will probably be paying 15 percent to 20 percent of the profits from your sale in taxes. Income tax at the state level also adds to the cost — as much as 13 percent for taxpayers in California or New York City, for example. In markets that tripled since March 2009, this makes the tax issue very challenging. In quite a few portfolios, even a perfectly timed exit and re-entry is at best a break even.

Then consider short-term gains, which are taxed as ordinary income — or as much as 39.6 percent.

So should you sell? That isn’t the sort of advice I can give anyone in a column. But I can suggest you consider these questions. They can help give you direction in your decision-making.

 

Originally: The Question of When to Sell Isn’t So Simple 

 

 

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