Do You Have a Reason to Sell?

by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
August 27, 2007

Buy, sell or hold? These are the eternal questions investors everywhere face. Of the three, investors seem to struggle most with the decision to sell.

In Get A Tax Break By Harvesting Losses, we suggested three fundamental reasons to sell a security:

You need the cash.
You have an alternative, potentially better investment in mind.
You wish to harvest income tax losses.

In that article, we went into detail on the mechanics of harvesting losses, but only touched briefly on the first two items. Let's take a closer look at the other two fundamental reasons for selling a security.

You need the cash
Most of us know it's a good idea to keep sufficient cash reserves for unexpected expenses and only commit long-term investment money to volatile markets.

Ultimately, however, your portfolio is a tool that you likely mean to use someday. Chances are, you eventually will sell some stocks to one degree or another in order to fund various long-term goals, ideally as part of a thoughtful distribution scheme that combines cash-flow planning with portfolio rebalancing. Enjoying the fruits of a prudent long-term investment plan is what it's all about.

It's important to recognize the difference between unexpectedly having to raise cash in a forced sale at the worst possible time and the strategic use of your portfolio over an appropriate, predetermined time frame. Given the latter, selling to raise cash can be a legitimate, prudent motivation. In this case, seeking an appropriate investment alternative is not a factor.

You have an alternative, potentially better investment
If you sell a security but don't plan to spend the proceeds, the logical choice is to switch to a potentially better investment. This category is something of a catchall, and could include any of the following:

Portfolio rebalancing. If your portfolio asset allocation is out of balance—with stocks overweight to your normal allocation, for example—you might sell some stocks in order to purchase bonds to get back into balance (or the other way around, if the bond portion becomes overweighted). Here, the "better alternative investment" is dictated by your overall portfolio investment policy.
Concentrated position. Similar to rebalancing your portfolio by broad asset class, you may find that you're over-concentrated in a specific stock, industry or sector. If you choose to sell down to a prudent level and redeploy the proceeds, you'll need to find an alternative, more suitable investment.
Price target reached. Many investors set predetermined price targets, either to the upside or downside, at which point they'll sell a particular security. If you aren't spending the money, then the logical assumption is that you'll reinvest the proceeds.

For some, temporarily parking the proceeds in cash (as an asset class, not for near-term spending) might represent a better alternative, despite the potential pitfalls and perils of attempting to time the market. However, if you have a long-term target allocation you wish to stick to, you'll eventually need to find an alternative investment.
Fundamental change. Irrespective of price targets or time horizons, a security may undergo significant, fundamental changes that you couldn't foresee when you bought it. For example, news about a company or industry could lead you to sell a particular stock or bond. Likewise, news about a mutual fund—such as a change in manager, investment philosophy or long-term performance—could impact your decision to sell.

A good question to ask in the face of changing fundamentals is, "Would I still buy this security today based on what I know now?" Again, assuming you decide to sell but intend to maintain your overall asset allocation, you have to find a suitable home for the proceeds—in which case you may want to check out Schwab's Mutual Fund Select List or Schwab Equity Ratings.

Reasons not to sell
The key word in this discussion is "reason." Try to avoid acting on emotion—for example, buying out of greed when times are good or selling out of fear when times are bad.

Resist the temptation to think you can consistently outsmart the market. Focus on an asset allocation suited to your long-term goals and have a reason for every decision to sell or buy. Think your decision through to its logical conclusion: Have you reached your goals and need the cash? Or, do you have an alternative, potentially better investment in mind? Does your decision have nothing to do with emotion? If so, then go ahead and sell.

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost.

Investment return and principal value will fluctuate, and redemption value may be more or less than original cost.

Charles Schwab & Co., Inc. receives remuneration from fund companies in the Mutual Fund OneSource® program for recordkeeping and shareholder services, and other administrative services. Schwab also may receive remuneration from transaction fee fund companies for certain administrative services.

The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information should not be construed as an offer to sell or a solicitation of an offer to buy any security. The investment strategies and the securities shown may not be suitable for you.

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