Selling shares when is it a good decision

Published in My Wealth Newsletter, Commonwealth Bank, September 2014 by Melanie Timbrell

While there is a lot of information available on how to approach buying shares, knowing when to sell a share, to realise your profit or minimise your loss, is every bit as important for an investor.

Jonathan Philpot, wealth management partner at HLB Mann Judd, says that selling is often a harder decision to get right than buying.

“When buying the decision is often more obvious, whereas when selling it’s harder because normally over a period if shares have performed well then you will have an emotional attachment to them which makes it difficult to sell.

“Often that’s why you see portfolios heavily overweighted to a particular stock that’s performed well,” Philpot says.

Selling shares doesn't have to mean exiting a company altogether. If you believe it still has good growth prospects but you want to realise some of your gains, for example, you might opt to sell a portion of your shares, which also reduces your exposure to that individual stock as a proportion of your overall portfolio.

Is your decision rational or emotional?

An emotional attachment to shares you are invested in can go the other way as well.

‘Loss aversion’ refers to a situation where the pain experienced as a consequence of a loss is greater than the perceived benefit that comes from a gain. 

It is unfortunately a fairly typical state for investors who, having bought into a particular stock, have a tendency to try and avoid realising a loss.

One way this can manifest itself is when people set a price limit for their shares, but then ignore it once they have skin in the game.

An example of this is deciding that if your stock falls below a certain level you will sell out and put a cap on your loss, however when that limit arrives you elect to hang on in the hope you will make up your loss.

Setting a price target is how brokers and analysts operate. 

Essentially, it is the point at which analysts feel the stock is fully valued and so the best outcome will be derived by exiting at that price.

Philpot warns that given companies are constantly releasing new information, the effect of which is what analysts monitor and model into the target price, setting these can be difficult for a DIY investor.

“Those figures are always changing depending on what’s going on so be careful about trying to do too much yourself,” Philpot says.

How does this move fit with your investment goals and strategy?

Before starting to invest you would likely have set yourself some goals and a strategy for growing your wealth and it is a good idea to consider how selling decisions fit with that.

There may be a number of motivating factors to sell shares, including personal reasons such as if your risk profile has changed due to a life event such as having a child, or more company-specific reasons, such as if the quality and performance of the business declines.

In this context keeping an investment journal can be useful as it will allow you to go back and see your rationale for buying shares in the first place and see if the company would still pass the tests you applied when you decided to buy.

Dale Gillham, executive director of Wealth Within, says setting some rules for yourself will help provide guidance on when to sell.

“A very important part of trading well and one that is pretty much ignored is working on your psychology, as how you approach your trading is critical to your success.

“Using a trading plan is also essential,” Gillham says.“No one would invest in any of Australia’s largest companies if the CEO came out and said they don’t have a plan to trade successfully.

“There is a reason why businesses have business plans and why traders should have trading plans and that is that both want to make a consistent profit.”

Is there a more compelling investment opportunity?

A key consideration is what alternatives there are for the use of the money you would receive from selling your shares.

Philpot says the question to ask is whether there is a better opportunity or indeed a better investment option for the sum of money you currently have invested, keeping in mind your investment goals.

This doesn’t necessarily have to be an alternative stock holding either – it could include an investment in any other asset type, including cash, if that is the better alternative for you at the time, Philpot says.

Tax considerations

While capital gains tax (CGT) often forms a significant consideration for people thinking of selling shares, given that investors qualify for a 50% discount on CGT if shares are held for more than 12 months, Philpot says it can be unwise to make this your primary consideration.

“It can be dangerous to be driven too much by tax and not wanting to pay capital gains,” Philpot said.

Holding onto a company of deteriorating quality, or where it is fully valued can result in losses far worse than the amount that paying CGT would have reduced your return by, Philpot says.

“Selling just because there is a capital loss might not be the best investment decision either – and it’s probably not wise to let your tax strategy get in the way of your investment strategy.”

Ultimately, Philpot says that it’s important to understand that if you are investing in shares, then there will be volatility involved.

“Shares are volatile and they will go through periods where they fall 20-30% in value.

"But overall it’s that volatility that is the reason they provide higher long-term returns than non-risk investments so you shouldn’t be scared of volatility in markets. The important thing is not to make rushed decisions because generally these tend to be the wrong ones.”

To learn how you can gain the required knowledge and skill to ensure your success in the stock market click here.

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