Course 303: When to Sell an Investment
Good Reasons To Sell
In this course
1 Introduction
2 How Selling Can Hurt
3 Bad Reasons To Sell
4 Good Reasons To Sell

Of course, it’s unlikely you'll hold most investments forever. You will need to sell investments from time to time. Just make sure you're selling for a good reason--and your reason should stem from your own investment philosophy and your investment-selection criteria.

The fundamentals of the investment change.

It's often tough to distinguish between the normal fluctuations of a company's stock price or a fund's performance from long-term shifts in fundamentals.

Let's say that because of a change in foreign-exchange rates, Coca-Cola (KO)earns a little less than analysts had expected in a given quarter and the stock's price takes a licking. Who cares? The company's long-term prospects aren't damaged.

But if the changes are deep enough, the reasons you bought the investment may no longer hold. Then, you'd consider selling.

Maybe you own a stock because the company is growing rapidly. But you find out about accounting irregularities at the company, which pull the rug out from under profits. You may still want to own the stock, but only if you're interested in turnarounds. It's no longer a growth stock.

The fundamentals can change with mutual funds, too. Presumably, you buy a small-value fund because you want exposure to small-value stocks. If the manager starts buying large-growth stocks, you may have a problem. You may now have multiple large-growth funds in your portfolio, and no small-value fund. You may need to sell to restore your original balance of styles.

You made a mistake.

Closely related to changing fundamentals are misunderstood fundamentals. If you buy a gas grill that won't light, or a shirt that doesn't fit, you return it. Sometimes investments need to be returned, too.

Let's take an example. Suppose a bond fund loses more than 20% in a year in which its average peers suffer a much slimmer lossbecause ithad made a big bet on emerging-markets debt. Shareholders who thought they were buying a boring multisector bond fund had every right to sell. They'd made a mistake.

Rather than hang on to a mistake in the hope it stays above water, it makes sense to switch the money to a more-compelling investment, one you feel comfortable with.

The best way to avoid such situations, of course, is to be a finicky buyer. Research your investments thoroughly. The Mutual Funds and Stocks tracks of the Investing Classroom can teach you how.

The investment becomes too expensive according to your criteria.
There's no reason an investment that's done well can't continue to do well.But when valuations rise, the investment's price is outpacing the business--the P in the P/E ratio is rising faster than the E. If you invest in a stock or mutual fund--not because you love the company or fund management but because the investment seems undervalued--a rise in valuations may mean it's time to move on.

Unfortunately, no hard-and-fast rules exist on when an investment becomes too expensive. That's up to you to determine as part of your investment philosophy.

For most investors, however, mutual funds don't become "too expensive" the same way stocks do. That's because fund managers are (theoretically, at least) selling the fully valued stocks in their portfolios and replacing them with better opportunities. They're defining what "too expensive" means, and they're weeding out pricey stocks based on their criteria.

Your portfolio needs rebalancing.

Let's say you had a balanced portfolio five years ago, with equal weightings in the four corners of the Morningstar style box--large value, large growth, small value, and small growth. Your portfolio probably wouldn't be today. More than likely, either large-company stocks have outperformed smaller companies during that time (or vice versa), or one style has dominated over the other. That once-balanced portfolio is likely out of whack today.

Prudence counsels spreading risks around, and that includes rebalancing a lopsided portfolio. For safety's sake, it pays to periodically check to see if your portfolio is diversified, with a good mix not only among styles, but among asset classes and sectors, too. That often means selling some winners and investing the proceeds in losers.

We cover how to rebalance a portfolio inPortfolio 305.

A better opportunity comes along.
Suppose the stock of a great company that you've been keeping your eye on suddenly drops. Or say a mutual fund that was closed for the past five years finally reopens.

When too-good-to-pass-up opportunities arise, it may make sense to sell some of the least-compelling parts of your portfolio to fund the purchase. Just be sure that these opportunities are well thought-out and investigated, that they fit your long-term investment goals, and that they meet the investment selection criteria you laid out in your Investment Policy Statement.

The investment doesn't live up to expectations.

While one year of underperformance may be nothing to worry about, two or three years of falling behind can get frustrating. Worse, if you're relying on the investment to offer a particular amount of return each year, on average, and it continually falls short, it may jeopardize your chances of meeting your financial goal.

Before pulling the selltrigger, be sure you're comparing your underperformer to an appropriate benchmark, such as its Morningstar category, its industry peers, or a suitable index.

Also, be sure that your investments continue to meet the other investment selection criteria in your Investment Policy Statement. If they don't, they may be sell candidates.

Your investment goals change.

We don't invest to win some imaginary race, but to meet our financial goals. As your goals change, your investments should change as well.

Suppose you start investing in a balanced fund with the goal of buying a house within the next five years. If you get married and your spouse already owns a house, you may decide to use that money for retirement instead. In that case, you might sell the balanced fund and buy a pure stock fund. Your goal and the time until you draw on your investment have changed. The investment should, too.

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