If you read the advice on the Internet, you know that you should sell all your stocks right now because a billionaire predicts an economic crisis so big that the Great Depression will seem like a debutante party. The currency will collapse, stocks will be worthless, and people will envy the Joads because at least they had a truck to throw themselves under.
If you listen to other, actual billionaires, such as Warren Buffett, youll hear that his favorite holding period is forever. Whos right?
As a rule, its better to follow bona fide billionaires with a track record, such as Buffett, as opposed to clickbait advertisements. Youll get your best returns from stocks over the long run, not by short-term trading. But even Buffett sells his holdings from time to time, and you should never hesitate to sell if its in your interest. When is that? Glad you asked.
Sell when your investment thesis just isnt working. You may have had great faith last year that RadioShack would be able to get out of its troubles. RadioShack was looking pretty darn cheap last year at $4.15 a share. Unfortunately, cheapness is relative, and RadioShack had no earnings last year, which explains the price. Had you bought on the assumption that things could only get better, well, you were mistaken. RadioShacks prospects still look dim, and its price has fallen to $1 a share. Your best bet: Take your loss and find a better place to put your money.
RadioShack is a relatively easy example. Lets say that you thought interest rates would rise, a reasonable investment conclusion, given how low rates are currently. And lets say you came to that conclusion at the end of 2010. So you decided to buy shares of Proshares Ultrashort Barclays 20+ Year Treasury ETF (TBT). The fund rises when bond prices fall and long-term bond yields rise.
Unfortunately, you were wrong: The fund fell 51% in 2011 and another 12% in 2012. It rose 24.8% in 2013, and its down 31.5% this year, according to Morningstar. Although the decline in long-term interest rates is breathtaking, that doesnt mean that they cant go further. Its always darkest before its pitch black, as former Fidelity manager Peter Lynch was fond of saying. Rather than assuming that the market is wrong, your best bet is to assume you are, take your losses and live to invest another day.
Sell when youre taking more risk than youre comfortable with. Lets say you were either very smart or very lucky and invested in Gilead Sciences in 2004. The biotech stock has averaged a gain of 27.39% every single year since then. A $10,000 investment would now be worth about $112,500, and you would have throw pillows made of crisp $20 bills. But Gilead is about as far as your luck has extended, and its now about half of your total portfolio.
You have a dilemma here. On the one hand, you have a stock that has rocketed and measurably improved your net worth. On the other hand, half your portfolio now rests upon the fortunes of one stock. Should you sell it all? No. But when a single issue takes up more than 20% of your portfolio, its time to think about taking a few chips off the table.
On a more commonplace level, suppose your goal was to reach $500,000 in your 401(k) plan. Youre 50 now, maxing out your contributions, and you have $400,000. Youre also 100% in stocks. You can probably reach your goal in 15 years without being 100% in stocks. And, as you get older, your ability to make up losses through increased contributions is falling every year. If you can get to your goal without being 100% in stocks, pare back a bit so you have less risk. Theres no reason to take more risk than you have to. You dont want Mr. Market to decide when you can retire.
Sell when you have a tax loss. If youre investing in stocks in a taxable account — and its generally a good idea to keep your stocks in a taxable account — you should always consider harvesting tax losses when you can. This is particularly true this year, because your long-term capital gains may be taxed at a higher rate than they were in 2013, making your capital losses all the more worthwhile.
You can use taxable losses to reduce any amount of long-term capital gains, which are gains on most stocks, mutual funds or exchange-traded funds held for a year or more. Lets say you have a $10,000 loss on RadioShack. You have $5,000 in long-term gains. You can use $5,000 of your losses to wipe out your $5,000 in gains. You can then deduct an additional $3,000 from your income at tax time and carry over the remaining $2,000 to the next tax year.
You cant re-purchase your loser for 30 days, or youll run afoul of the Internal Revenue Service, which will rule your loss a wash sale — meaning you cant take the loss. But in the grand scheme of things, 30 days isnt that long. You can wait until the wash sale period is over and repurchase RadioShack, if youre really a glutton for punishment.
Capital losses are taxed at 15% for most investments and investors, but if youre a single taxpayer with more than $406,751 in taxable income and a joint filer with more than $457,601 in taxable income, your capital gains rate is 20% — making losses all the more valuable.
Take your losses before Dec. 31, if you can — they will reduce your 2014 taxes. If you wait until January, you wont get the benefit until the 2015 tax year.
No one likes selling: It can be an admission of defeat, in the case of a losing investment. But sometimes, it just has to be done. Just make sure you dont sell because some guy on the Internet says everything is going to flinders. They havent been right yet.