In general, there are appropriate and inappropriate motives for selling a stock. While it is generally unwise to sell a stock just because its price has climbed or reduced, there are circumstances in which putting one or more sell orders is appropriate. Let’s examine numerous sensible reasons for selling a stock, when to sell stocks for profit or loss, and under what circumstances selling a stock is inappropriate.
List of Contents
- 6 Reasons for Selling a Stock
- 1. The company is being bought out.
- 2. You need the money or will need it soon.
- 3. You have changed your investing strategy.
- 4. You need to rebalance your investment portfolio.
- 5. You recognize possibilities to invest your money more wisely elsewhere.
- 6. You want to take advantage of tax-loss harvesting.
- Sell Stocks for Profit
- Sell Stocks at a Loss
- Determining Which Stocks to Sell
- When Not to Sell a Stock
6 Reasons for Selling a Stock
Here is a list of six situations that could sell a stock.
1. The company is being bought out.
One reason to sell a stock is if a company announces that it has agreed to be bought. Following the announcement of an acquisition, the firm’s stock price often climbs to a level near the agreed-upon purchase price. Since future upside potential may be limited, it may be prudent to lock in your profits soon following the purchase announcement.
How the company is bought influences whether selling your stock is the best option. A business can be purchased for cash, stock, or the two following combinations.
- In the case of all-cash acquisitions, the stock price usually quickly approaches the acquisition price. However, the company’s stock price may fall again if the transaction is not completed. It is rarely worthwhile to hang onto your shares long after announcing an all-cash acquisition.
- In the case of stock or cash-and-stock transactions, your decision to hold or sell should be based on whether you want to be a shareholder in the acquiring business. For example, Slack Technologies (NYSE: WORK) recently agreed to be bought in cash and equity by Salesforce (NYSE: CRM). Slack shareholders who do not wish to become Salesforce investors should cash out.
2. You need the money or will need it soon.
It is typically a good idea not to invest in the stock market with the money you will need in the next few years. However, selling is a perfectly reasonable cause if you need the money. One possible reason is when you want to buy a house and sell some stock to make the down payment. Alternatively, you may have children who will be attending college in a few years and wish to transfer your stock holdings into more secure investments such as certificates of deposit (CDs).
3. You have changed your investing strategy.
The reasons you purchased a stock may no longer be valid. You should consider why you bought a stock in the first place and whether those reasons are still valid. Other than the desire to generate money, you should have a reason or an investment thesis for each stock investment. If anything fundamental about the company or its shares changes, it may be time to sell. The examples are as follows.
- Sales growth has slowed substantially.
- The company’s market share is decreasing, possibly due to a competitor offering a superior product at a lower price.
- The company’s management has changed, and the new leadership is making irresponsible choices, such as taking on excessive debt.
This is not an exhaustive list. One of the best reasons to sell is if something significant changes that contradicts your investment strategy.
4. You need to rebalance your investment portfolio.
In one or more ways, your financial portfolio can become unbalanced. That is why most investors must rebalance their portfolios regularly, which may include selling some shares. The following are two of the most common events that precede a stock sale.
- You want to reduce your stock exposure.
It is good to progressively lower your stock holdings in favor of safer investments such as bonds as you approach retirement. A common rule of thumb for determining the proportion of your portfolio that should be invested in equities is to subtract your age from 110. If your portfolio contains too many stocks, it may be prudent to sell some to reallocate your resources.
- You want to own a stock that performs well.
If you possess stocks that have experienced significant price appreciation, your stake in the company may account for a major amount of your portfolio’s worth. Although this is a desirable problem to have, you may not be comfortable having so much of your money invested in a single firm and decide to sell some of your stock.
5. You recognize possibilities to invest your money more wisely elsewhere.
You would always have extra income to invest whenever an interesting investment opportunity presents itself. Since this is most likely not the case, you may elect to sell stocks and invest the proceeds in a different manner.
Suppose you discover an exceptional purchasing opportunity for one of your favorite stocks and decide to commit 10% of your portfolio to this purchase. If you do not have 10% of your portfolio in cash, you may elect to sell some of your other stocks or exchange-traded funds (ETFs) to generate cash. There is certainly nothing wrong with the other stock or ETF; nevertheless, identifying an outstanding long-term opportunity elsewhere can be a solid cause to sell.
6. You want to take advantage of tax-loss harvesting.
If you have losses in some of your investments, you may want to sell them to take advantage of the tax-loss harvesting technique. This method permits you to reduce your tax liability by offsetting income and capital gains with losses.
The IRS permits you to claim up to $3,000 in annual losses, which might result in significant tax savings. If your losses exceed the $3,000 threshold, you can carry over the excess losses to offset future gains. This method is only appropriate for taxable funds, not retirement accounts such as 401(k)s and IRAs. However, avoid letting tax considerations influence your investment decisions. Trading in and out of strong companies for tax or other objectives will frequently leave you worse off than if you had simply kept the stock for the long run.
Sell Stocks for Profit
Any of those mentioned above are viable reasons for selling a stock for a profit. Profiting from an investment might provide additional justification for selling the stock to fund a significant purchase, retirement expenditures, or as part of a portfolio allocation strategy.
However, do not sell a stock for a profit simply because its price has climbed. This would be a mistaken belief that it is good to take some money off the table if a stock appreciates.
Sell Stocks at a Loss
Meanwhile, selling a stock solely as its price has fallen is typically unwise. Nonetheless, there are instances when you must cut your losses on a stock position. It is necessary not to let a stock’s price decline prevent you from selling. If your original rationale for purchasing a stock no longer applies, or if you were simply mistaken about the firm, selling at a loss may be preferable to continuing to hold.
Determining Which Stocks to Sell
Before you decide to sell a stock, it is essential to determine which stock will be sold first, as this decision can affect your tax condition. First-in, first-out (FIFO) is the standard method for selling stock unless otherwise specified. For instance, suppose you purchased 50 shares of a corporation each year and paid $10, $15, $20, and $15 each share, respectively, over four years. Suddenly, you need money for an emergency, and the stock’s share price is at an all-time high of $25.
If you decide to sell 50 shares, you normally sell the first-year shares at $10 per share. When you place the sell order, you can choose which shares to sell if you choose to retain ownership. In other words, selecting the shares you paid the most ($20) can reduce the amount of capital gain and, thus, the amount of taxes owed. If you sold the shares with a $20 purchase price for $25, you would only enjoy a $5 gain per share. If the stock price goes back to $15, you would have missed a $15 per share profit on the $10 per share shares you purchased in the first year.
When Not to Sell a Stock
It is essential to properly understand when not to sell a stock. Here is a list of circumstances in which it is unwise to sell your stocks.
1. Do not sell a stock only because its price has risen.
The price of winning stocks increases for a reason, and they are also likely to continue winning.
2. Do not sell a stock only because its price fell.
Every investor wants to purchase at a discount and sell at a profit. Selling a stock because its price has fallen is essentially the reverse of what should be done.
3. Do not sell stocks to reduce your tax liability.
Even though a tax strategy known as tax loss harvesting might reduce your taxable capital, selling stocks only to reduce your taxes is a bad idea. Tax loss harvesting can be an effective tax-saving technique, but only if you sell a losing investment for other acceptable reasons.
In summary, selling an investment is similar to purchasing one. You must ensure that it aligns with your investment and financial objectives. Additionally, it is essential to comprehend your risk tolerance and time horizon. Moreover, you should seek the assistance of a financial advisor in developing a short-term and long-term financial strategy.
When selling stocks, some common mistakes to avoid are selling too quickly out of fear, not thinking about taxes, selling all your stocks at once, focusing too much on short-term gains, and not paying attention to the fundamentals of the companies whose stocks you’re selling.
The best time to sell a stock for a profit is when its price has gone up a lot since you bought it, and you have made the amount of money you wanted. Before selling, it’s also important to think about the market as a whole and the company’s financial health.
When you sell stocks, you might have to pay capital gains tax. This tax is based on the difference between how much the stock is sold for and how much it costs to buy. The tax rate depends on how long you hold on to a stock. Long-term investments have lower tax rates. You may also have to report the sale on your income tax return and pay taxes on any dividends you get.
To reduce your capital gains tax liability, you can keep the stock for at least a year before selling it to qualify for the lower long-term capital gains tax rate, or you can consider timing your sales to limit profits in high-income years and maximize losses in low-income years. Additional techniques include harvesting tax losses, utilizing tax-favored accounts, and transferring valuable assets to charity.
If a stock’s price goes below your specified stop-loss level, you should consider selling A stock to reduce your losses.
Read more: Stocks
Source: Investopedia, Fool