When do you sell a stock?

May 4 6 Comments latest by James stern

Almost as often as “What stock should I buy?” is the question “When do I sell it?” Let’s take a journey into the wonderful world of selling a stock. Christ, I can’t believe I actually wrote that. Ok anyway, here we go…

Here’s a little analysis of some Dell stock I own.

Dell stock (3 months)

Stupid person: Ooh, scary, look how much it dropped!! I guess I should sell it immediately so I don’t lose the rest!!! OH GOD (weeping).
Smart person: Hey, the chart only represents 3 months of trading! Plus, what is the context of these numbers? What did the rest of the market do?

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Dell stock (1 year)

Ok, now we’re seeing a little difference here. It appears that the stock took a huge upswing around November ‘04 and has returned back to those levels now.

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Dell and the S&P 500(1 year)

It appears the market (in red) was doing similarly poorly. So we can see that Dell is basically following market progress. This is good–if the market went UP and Dell went DOWN, that would be a problem.

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Dell and the S&P 500 (10 years)

OH MY GOD. Pay close attention to the numbers on the Y axis.

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I ripped these graphs off of Yahoo for a reason. Lots of people ask me “When should I sell?” So here’s the answer:

First, you should be thinking more about buying rather than selling. Of all the stocks I’ve ever bought, I’ve only sold once or twice. Buy-and-hold investing wins, remember.

Second, when I teach my classes, I draw a picture of a rapidly falling stock. Then I ask, “What should I do?” About 25% of people shout out “Sell!” and 25% say “Hold it!” A couple of people mutter “Buy more” and the rest are apparently mutes.

But the truth is, you need more context. If a stock like, say, Dell falls a bunch, you have to look at the surrounding context. Is the general market falling? Are its peers (Compaq, HP, etc) falling? If so, Dell may actually be outperforming its market. On the other hand, if all the other tech companies are doing really well, that’s a red flag.

Now, there are some clear-cut times to sell. One of my friends bought some stock because he wanted $5,000 for a new-car down payment. Once he made the money in his stock, he sold it. Great–he achieved his goal and moved on. I like that.

Sometimes, when other people sell stocks en masse, they can become immensely attractive because of this short-term stupidity. Refer back to my example of how Ebay dropped 20% in one day because they missed expectations by a penny. If on that day you still thought Ebay was a good fundamental investment, you could have bought it for a discount price.

Why not sell immediately if you make a certain return? There are a number of reasons, the most important of which is taxes and trading fees. Look:

If you’re in the 15% income tax bracket
Sell in under a year: You pay 15% tax on any capital gains
Sell in over a year: You pay only 5% capital-gains tax

If you’re above the 15% tax bracket
Sell in under a year: You pay tax on your capital gains at your your income-tax rate, which is between 25% and 35%
Sell in over a year: You pay only 15% capital-gains tax

The other reason is that we’re just terrible at timing the market. If the stock went up 10% this year, you can sell and keep that 10% (actually less because of taxes/trading fees). But if it’s a good fundamental investment and you hold it for a long time, you’ll make infinitely more than a trifling 10%.

Bottom line? Don’t just sell because your stock dropped. Look at it in context PLEASE BEFORE I KILL MYSELF AFTER HEARING ANOTHER STORY OF SOMEONE SELLING THEIR STOCK FOR A 4% RETURN AFTER TAXES AND BEING HAPPY ABOUT IT. Good day.

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Posted May 4, 2005 under Investing

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