Investors generally buy stock for one reason. They ultimately expect an attractive return on their investment. That return can be in the form of dividends, interest, rents, or capital gains. Unlike buying, however, knowing when to sell stock can be tricky. Some of the most common reasons you should sell out of a stock investment are as follows:
Short Investment Time Horizon
If you invested funds that you will need for another use within a short term time horizon, then you should probably look for an exit. Anything less than five years is considered by many a short term time frame for this purpose. For example, you may be looking to buy a home and need the money for down payment. Alternatively, you may be approaching retirement and will need use of the funds for daily living expenses. In any case when it is clear that you will require use of the invested funds for other purposes, you cannot afford to have those funds invested in the stock market. Stock markets are volatile and as such are not an ideal place for investments when you have a short term time horizon.
Sell Stock To Raise Funds for Another Opportunity
You may be fully invested in your portfolio when a rare opportunity presents itself. Passing on the opportunity may be difficult. So what do you do if you do not have investable funds to add to your account? You look through your portfolio and sell something else to raise funds for the new opportunity. Ideally, you would sell an investment which is the most overvalued and unattractive. Then use the funds to buy the more promising one that is substantially undervalued.
Portfolios may need diversification for many reasons. For example, your investments from one sector may have had a good run and now constitute an outsized portion of your overall portfolio. Some selling can help reduce the concentration in one area. Alternatively you may inherit an investment account which is invested in only a few stocks. Selling in such a situation would also be wise as you can reduce your overall risk by diversifying into several investments.
Fundamentals or Price of the Company Have Changed or You Made a Mistake
You may invest in a company because you think the market is currently undervaluing it. But there are three reasons why such an investment can become fairly valued or overvalued. First, the price can increase to the point where the valuation is less appealing. Second, the fundamentals of the company can deteriorate, causing the discount to price to disappear. Finally, you may have picked up on a mistake in your initial analysis which made you realize that the company was never a bargain in the first place. Any of these scenarios may be reason to sell, but the latter two should certainly make you exit the investment.
Note that is is important to keep track of the costs of selling as well. Just like when you buy a stock, you pay a commission every time you sell. Also, selling appreciated stock will generate capital gains, which can affect your tax liability. Click here for more investing related articles.