Market truth: “For the typical investor; there are only two ways to make money in the stock market: 1) through dividend payments or interest baring securities, or 2) through the appreciation in the value of the security you purchased. Please understand, however, that if are relying on value appreciation you neither make money nor lose money until after you sell the security.”
The market truth stated above should be in the mind of any investor. It gives the investor at least a vague idea of when to sell a security.
As you know when you buy a stock or a bundle of stocks (mutual fund, ETF, ETN) you are buying an asset the value of which may increase or decrease. As we were reminded during the last recession, your home value may also increase or decrease over time. But to make or lose money on your home you have to sell it. Example: if you buy your home at say $200,000 and the housing market in your neighborhood goes up over the next few years to where the value of your home is now $250,000; if you sell your home at that time you will “make money” on your home – $50,000. (minus mortgage interest, repairs, etc. … you understand) However, what if you don’t want to move at that time, what if you can’t move at that time, what if you feel you can make more money on your home if you wait? Now let’s say you do wait, but over the next three years the housing market crashes – your home is now worth $175,000. What should you do? If you lose your job over that time or your company relocates you, you may have to sell your home and therefore “lose money.” But if you’re not being forced to move, do you really want to sell your home right now? Yet, for some reason many MANY people don’t view the stock market with the same set of glasses.
There are only three choices you make in the stock market: buy, sell, or hold (I not going to get into margin, options, futures, etc, but all of the alternatives have the same choices attached). The reason most people get into the stock market is to “make money.” If making money is your goal then simply sell your assets (your stocks) after their value is greater than they were when you purchased them. Simple, right?
“But what if my portfolio is trending down,” you may ask. In our opinion there are only three reasons you should ever sell at a loss: 1) if you have to; 2) if it benefits you; 3) if you are confident some other investment vehicle will perform better than what you are already in. Let’s look at these options individually.
- Do I have to sell? If your portfolio is down do you have time to wait for it to go back up, or do you need the funds tied up in the these assets in the near future? HISTORICALLY SPEAKING the market goes up; it’s designed to; these are growing businesses in an advancing capitalistic world. Yes, during periods the market goes down (even a lot), but if you would have invested $10 from the beginning of the market and left it there until today, you would have A LOT more than $10. Despite the great depression, the oil embargo, Black Monday, 9/11, the bursting of the tech bubble and the housing bubble, the market has gone up. Despite all of the aforementioned events, the big companies you know – Apple, Microsoft, GM, GE, Johnson & Johnson, Ford, etc. – have bounced back. In fact, even if you had bought in at the very top of the last economic crisis and rode the storm through today (8/24/15), your portfolio value would be worth more than the day you invested it. Most of the people that I know who “lost everything” in the stock market (which I have known only two, neither of who’s portfolios actually went to zero) were either forced to sell their portfolios to pay off other debts or needed the funds live on during an economic crisis or the loss of a job when the market was down; or they panicked and sold near the bottom of some significant market crash. But if you had the 5 years to wait out the last economic storm (even if you had bought in at the very top) you wouldn’t have lost a dime – as long as you didn’t sell.
- Can I benefit from a loss? There is one way to benefit from selling a security at a loss – tax write down. When you sell a security you have created a taxable event – meaning you have made or lost money and Uncle Sam wants to know about it. The losses sustained from the sale of securities can be used to offset other taxable gains or income. There are rules and limits, but you can learn more here: http://www.irs.gov/uac/Ten-Important-Facts-About-Capital-Gains-and-Losses.
- Are there better opportunities? If your portfolio is invested, but down, you should remember that those losses are “paper losses” – they represent the loss you would take if you sell right now. If your portfolio is down 10% right now, it may only be down 6% tomorrow; or maybe down 15% tomorrow; but, again, money is only made or lost when you sell. So if you are thinking about accepting a loss (“realizing” a loss) because you want to sell, the question you should be asking is “what do I do with my money then?” Do I put it back in my bank account earning .12% interest? Maybe, if you don’t feel confident any investment will perform better, but depending on the size of the loss taken it may take a while just to get back to even. Are there better opportunities out there? Maybe, but in either case only time will tell whether it was wiser to cash out, stay put, or invest elsewhere. So If you own a company or an asset class that looks to be on a long-term downward trend, with little hope of a bounce back, and you feel confident that another company or asset class could do better than the one you’re in, this may be a reason to sell at a loss. However, because the future is always unknown, make sure you have more confidence in your next investment than in the one you’re getting out of.
Lastly, one may wonder, “well can’t I just avoid the ride down?” Attempting to do this is what professionals’ call “trying to time the market” – getting out at the top of a market high and reentering at the bottom or near the bottom. One can attempt to do this, but most people who try end up missing the top, taking a significant tumble, pulling out, and then waiting until it’s “safe” to get back in the market; by which time they have missed much of the upswing. Be aware that missing just 10 of these upswing days can have huge impacts on your portfolio. (See http://www.businessinsider.com/cost-of-missing-10-best-days-in-sp-500-2014-3)
Because you’ve hired us to manage most of these decisions for you, and because we have confidence in our investment methodology, our typical advice is: stay the course.