While a significant percentage of investors are generally a big fan of ‘buy and hold’ investing, they would also agree that it makes sense to unload a bad investment. Similarly, there are times when it’s smart to take some profits from an investment that has done well. But how else do you gauge when to sell?
“Trying to find the right timing for the sale of a stock, mutual fund, or other investment is hard, but it helps if you have mapped out an ‘exit strategy’ — a set of guidelines to give you a sense of when to sell,” said Brody Dunn, an investment manager at a UAE-based asset advisory firm.
Trying to find the right timing for the sale of a stock, mutual fund, or other investment is hard, but it helps if you have mapped out an ‘exit strategy’
“The right ‘exit strategy’ can help you maximise profits from good investments and reduce losses on bad ones.” So if you have been pondering on how you can limit your losses when selling an investment, ask yourself if any of the below warning signs apply to you or your investment.
Warning sign #1: Investment is in an industry that’s not expected to rebound
If you own shares of a company that’s struggling, it’s fine to wait and see if management can turn things around. But often, the company is in an industry that is in a downward spiral with no signs of recovery.
“There are some business sectors that are simply dying as a result of changes to technology, consumer habits, or other reasons. If you own shares of a company that’s part of a shrinking industry with no signs of renewal, it’s probably time to get out,” Dunn added.
For instance, you may have bought shares in a manufacturer of a substance that was later banned or a miner that processes minerals from a metal that’s no longer used by companies worldwide.
“If you’ve made a bad investment, get out of it to whatever extent you can. Accept the damage so you can start to move on. You won’t be able to move on to your next investment while you’re still holding on to hope that the current one will magically turn around,” added Dunn.
Warning sign #2: When your stock investment is priced too high
It’s important to know when to sell a stock when it’s a loser, but there are times when you should consider unloading a stock when it’s performed exceptionally well.
“The point of owning a stock is to profit, so once a healthy profit has been reached, it’s smart to at least consider taking your profits and investing them elsewhere. This is especially true when a stock is overpriced and potentially due for a fall,” explained Aditya Srivatsav, a Dubai-based market analyst.
“One way to determine if a stock is too hot is its price-to-earnings ratio. An average price-to-earnings ratio is between 20 and 25, though it can vary depending on industry.”
Ratios can go higher if investors are betting on future growth. But if the ratio is high and you’re not confident of the growth path of the company, consider taking your profits and moving on.
The point of owning a stock is to profit, so once a healthy profit has been reached, it’s smart to at least consider taking your profits and investing them elsewhere
Warning sign #3: You wouldn’t consider buying the stock now
“If you own a struggling stock, it’s often important to ask yourself whether you would buy the stock today,” added Srivatsav.
“It often makes sense to buy stock when it’s priced very low if you believe it will rise and make you a profit over time. But if you reflect on a stock you own and realise that you’d probably pass on buying if it was presented to you now, that’s a sign that it may be time to unload.”
When crafting an exit strategy, Dunn suggested noting the lowest price at which you’d be willing to buy a stock, and once shares dip to that point, consider selling.
Warning sign #4: You’re breaking the 10 per cent rule
It’s not so much a rule but a guideline that many financial planners use to prevent big losses. “If you have an investment that has lost 10 per cent of its value in a short amount of time, it may be wise to sell before it goes down further,” said Dunn.
You can even put in place a ‘stop order’, which is a pre-set instruction to automatically sell a security once it hits a certain price. For example, if you buy a stock at Dh180, consider setting up a ‘stop order’ to automatically sell it at Dh162.
“By using a ‘stop order’, you have the peace of mind to know that the investment will sell even if you are not paying close attention. It’s also possible to put in a sell order when a stock reaches a predetermined high point, so you can take profits without worry,” added Dunn.
The 1 per cent approach will prevent one dud investment from ruining your overall retirement nest egg
Warning sign #5: You’re breaking the 1 per cent rule
Under this rule, the idea is that you never want a single investment to cost you more than 1 percent of your total portfolio.
So for example, if you have Dh100,000 saved in a retirement fund, you don’t want to lose more than Dh1,000 from a single stock or mutual fund.
“The 1 per cent approach will prevent one dud investment from ruining your overall retirement nest egg,” explained Srivatsav, who has also been investing in stock markets for over three decades now.
Warning sign #6: There are other good investments available
There are some instances when it’s alright to stick with a subpar investment because there are few other good places to put your money.
“If interest rates are low and the market is performing badly, it might make sense to wait and see if an investment rebounds. But if you find yourself wishing you could put your money in other, better-performing investments, maybe it’s time to sell,” added Srivatsav.
“There is a cost to selling, but if you free up cash to purchase something that is more likely to net you a profit, you may end up doing better in the long run.”
What do I do when I realise the investment I have has turned non-profitable?
Unless you need the money soon (or you suspect the company is going out of business), there's not much downside to holding onto a stock, since the price will almost inevitably rise again. In fact, this is the approach most experts recommend — buy and hold a stock, staying steady through the dips.
“A company that seems like a dud now might have a great turnaround later. Consider Facebook, which had a lacklustre initial public offering in 2012, and the stock languished below $30 (Dh110) per share for months. Now it's trading above $150 (Dh550),” Dunn added, who owns shares in Facebook.
“If you've lost your patience with a stock, it can under some circumstances be fine to consider investing your money elsewhere. But consider the cost implications of selling — such a, trading fees, and the costs associated with the new stock or fund.”
Are you sure the stock is a lost cause, or is it just undervalued? For example, in April 2020 several experts recommend buying energy stocks, which pummelled to sub-zero oil prices. But as oil prices eventually rose, it made a good opportunity then to buy those stocks on the cheap.
“You shouldn't worry too much about such stocks if you have a wide range of investments. Seek to hold a good mix of differently valued stocks in various industries, and no single stock should comprise a significant percentage of your portfolio,” noted Srivatsav.
“It may also be worth it to explore international investments, real estate, and bonds. Index-tracked funds are an easy way to get diversified. The point is that if you have a good mix of investments, that underperforming stock shouldn't be a major source of anxiety.”
