When you invest in stocks, you have two decisions to make. The first is what to buy and when to buy it. The second is when to sell.
The first decisionÂ actually might be the easier of the two. Selling stock can involve decisions that are both numbers-based and emotional. Some investors develop an attachment to certain stocks â€” maybe their parents owned the stock or they donâ€™t want to admit that it was a mistake to buy the stock in the first place. Or perhaps they see the stock market heading downward and want to sell out of fear.
The decision to sell any investment should be based upon factors relating to your financial plan and your investment strategy, not your emotions. Hereâ€™s what to think about before selling.
â€śStocks will do one of three things: go up, go down or go nowhere. You need to know before you buy it what youâ€™re going to do when these three things happen,â€ť said Charles Scott, a Scottsdale, Ariz., financial advisor and owner of Pelleton Capital Management.
When you buy any stock, itâ€™s a good idea to set price goals. These might be along the lines of â€śIâ€™d sell if the stock rose X% or lost Y%.â€ť If the stock hits either of those targets, it is a good time to review the holding and decide if it makes sense to continue to own it.
If the price of a stock rises rapidly, take a closer look and decide what the future may hold. Is the stock likely to continue to rise, or might it take a tumble from these highs? Thereâ€™s nothing wrong with taking a nice profit and investing the money elsewhere.
The same goes for stocks in decline. â€śInvestors should set a percentage loss they are willing to take on every stock purchase â€” whether it be 10%, 20% or more depends on their investment time horizon and philosophy,â€ť explained financial advisor Peter Huminski, president of Thorium Wealth Management. â€śSometimes stocks go down and itâ€™s time to sell for a loss. As the expression goes, your best loss is your first loss.â€ť
Scott suggested using stop orders when purchasing individual stocks. A stop order can be placed above or below the current share price. Once the stock hits your desired price, the order automatically will trigger a sale. For example, you could set a stop price both 15% above and 15% below the current price. This can help take the emotion out of the sale and allow you to sell at the target price you originally intended.
Stop orders can be adjusted. For example, if the price of the stock rises, you might move your desired price up or down accordingly.
Ideally, you wouldnâ€™t purchase stocks with money that might be needed for other purposes. Emergency fundsÂ often are best stored in safer, less volatile accounts. Unfortunately, things donâ€™t always work out as planned.
If your spare cash is depleted and you need more money fast, look at your portfolio and try to find stocks that make the most sense to sell. If possible, take a look at your gains or losses on the stocks to gauge the tax implications. (More on tax consequences below.)
One thing that makes the stock market so hard to predict is the number of variables that can affect share prices. An investment that made sense a year ago may no longer be wise if core variables have changed. For instance:
Itâ€™s always a good idea for investors to stay on top of news and developments regarding any stock they own. If there are major shifts that affect the company, itâ€™s wise to re-evaluate and ensure your investment still makes sense.
As markets go up and down, your portfolio will need to be rebalanced back to your target asset allocation over time. If stocks rise, you might find that you are overallocated to equities and perhaps taking more risk than desired. Selling all or a portion of your stock holdings might be appropriate to bring your portfolio back into balance.
Your employer might offer the opportunity to buy the companyâ€™s stock on a discounted basis or as an option in your 401(k) plan, or you might be able to buy the stock as part of your compensation. Regardless of how you acquire the shares, itâ€™s wise to limit your exposure to the stock of your employer.
Your livelihood is tied to the company via your compensation. If the company encounters financial trouble, you might find yourself out of a job while simultaneously learning that your net worth has declined because of your excessive exposure to its stock.
If you own the shares in a taxable account, there are tax implications to consider when you sell stocks.
If the shares are worth more than you paid for them, you will need to pay taxes on the amount of your earnings. Long-term capital gains, for shares held for at least a year, typically are taxed at preferential tax rates. Short-term capital gains, for shares held for less than a year, are taxed at your ordinary income tax rate, which is generally higher.
Shares sold at a loss are classified as short-term or long-term as well, and you can use losses to reduce the capital gains youâ€™re taxed on. For instance, if you sell stock A for a profit of $1,000 and sell stock B for a loss of of $300, you can reduce your total capital gains to $700. By reducing your capital gains, you also reduce your tax burden.
Investing decisions should not be based primarily on tax considerations, but you should be aware of the tax impact before selling shares so you can plan accordingly.
There are a number of things to consider before you decide when to sell stocks. Be sure that you are prepared to look at the sale in the context of your overall financial planning and investing situation before deciding to sell.
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