A common question that is asked in investing is: how long should I hold on to stocks? Like many things in investing the answer is not always straight forward, but there are several indicators that will help you make that decision. The short answer to the question is that there’s no universal rule that applies to all stocks when it comes to holding periods. If you are a value investor there are some basic rules that aren’t necessarily about when to sell a stock, but they have to do with what you should expect when you buy the stock.
Don’t Hold a Stock For Less Than 1 Year
The first rule is that you should never sell a stock that you haven’t owned for more than one year. Paying high capital gains tax is just not worth it, and selling before the year is up implies you made a mistake when you bought it. In fact the rule of thumb should be:
Don’t buy a stock if you don’t intend to hold it forever
To a stock trader that may sound like a crazy statement since they trade very frequently, maybe even daily. To a value investor that is part of the basic principles of investing and there are good reasons for having that point of view.
- Intrinsic Stock Valuations
Before a value investor makes a purchase one of the first things they will have done is calculate the intrinsic value of the stock. That calculation is based on the present value of all future free cash flow. In theory, that means that selling before your holding period is over will lead to leaving value on the table if you did your calculations correctly.
- You Did Your Homework
Since you did your homework before you even bought the stock, you should be undeterred if there’s a momentary market downturn. You should have fully vetted the company with the analysis that led you to believe that the fundamentals where strong and the company was a long term investment capable of thriving over time. In fact if you did your due diligence in the beginning and were happy with the decision to buy, market downturns can be a great time to increase your holdings and buy more shares.
When to Sell
Regardless of how you came to acquire the stock there are certain circumstances when selling the stock may be the best option. Those scenarios may include:
- The Company Changes
If there are significant changes in management that bring a difference in philosophy and no longer align with the values that led you to purchase the company in the first place it may be a good time to reconsider your ownership. Changes in strategy or the company exiting a line of business that you believe is core to the company or would adversely affect it’s ability to bank FCF in the future would also be valid reasons to sell.
- Stock Appreciates Significantly
If the stock has appreciated beyond the point where the economics no longer support the high price. While it’s always great to go along for the ride of high flying companies, if the price is being driven by hype and not fundamentals, it’s a good idea to start selling some shares. If you’d still like to see where the price will go you can sell the principal or the value of your original investment and stay invested with the gains of the shares that have appreciated since you bought into the stock. This approach would allow you to avoid a loss of your principal.
- You Need the Cash
There are times when you just need the cash. If it is unavoidable that you must sell a value investment you should attempt to to do so in the most tax efficient way possible. That is to minimize your tax liability by avoiding short term capital gains if possible, or picking the stock in your portfolio that would be the least painful to sell.
- You Made a Terrible Mistake
Sometimes you just made a mistake. You should do everything to ensure that you don’t make one, but if you’ve discovered that you were just wrong in your assessment, it may make sense to just cut your loses and move on. In value investing there are many checks and balances along the way to catch obvious issues, but occasionally you may fat-finger a calculation and day dream during your review of the 10K report. In those rare instances you should correct the error in the least costly way possible.
When Not to Sell
While there are times that it makes sense to sell stocks in your portfolio, there are times when it’s just not a good idea to sell shares.
- Volatility Scares You
Markets go up and they go down. Sometimes that pattern happens in a condensed period of time making things seem uneasy and unpredictable. Those types of movements tend to make some investors nervous about losing their investments. The thing to do here is to trust your research. Selling a stock should be a calculated decision not something based on a knee-jerk reactions or emotions. When it comes to money people can behave in irrational ways, but having done your research and maintaining a cool head will enable you to navigate through volatile markets and reach your financial objectives. Read our post on What to Do When the Market is Crashing.
- You Get Bad Advice
You can get investment tips from just about anyone you ask, and sometimes you don’t even need to ask to get it. People will volunteer their opinion on your investments without knowing what led you to buy the. For that reason it is always important to ignore the investing tips from people that don’t know your investments or your strategy. Stock tips to buy or sell a stock a usually given by people that don’t know much about the company and are just relaying an opinion they heard someone talk about. Don’t take advice from those people.
At the end of the day, you should evaluate whether it makes sense to sell a stock just like you did when you first bought it.