From Money Magazine, October 2006
The biggest challenge for sharemarket investors is deciding which stocks to buy. Not far behind is the task of handling the flip-side of investing – deciding when to sell.
For a lucky few it is an issue that never arises. Having chosen well in the first place they simply hold on for the long term, watching their share portfolio grow in value as it delivers an ever increasing stream of dividends.
"There are some exceptions but for most investors, for most stocks, this is the wise approach," says Andrew Dougherty, research manager with Aspect Huntley, one of Australia's most respected sharemarket research groups.
The emphasis, he says, needs to be put on getting your stock selection right in the first place. If you do that, why sell?
After all, most who sell will then need to go through the process of reinvesting the proceeds. What’s more, selling is likely to trigger a capital gains tax bill.
Dougherty says the recent sharemarket volatility has almost certainly prompted many investors to sell shares they should have continued to hold for the long term.
"Selling in response to an overall change in market conditions is rarely sensible for the average investor," he says, especially given the difficulty of accurately forecasting economic and business trends.
There are, however, a few sectors which are historically very cyclical, such as mining and the housing/construction sectors. As a result, monitoring these in order to sell before the next downswing can make good sense.
Stockbroker Marcus Padley, author of the daily stockmarket newsletter Marcus Today, puts more emphasis on wider economic and market conditions. In his view these point to difficult times ahead for share investors.
Padley stresses, however, that this is not a reason for wholesale selling. Rather investors simply need to have realistic expectations about how their portfolios are likely to perform during this period.
He notes that at this stage China's economic performance continues to be locked at a peak. "As long as it stays there our big resources stocks, BHP and Rio, are immune from the domestic cycle," he says, adding that this means there seems to be little reason to sell either.
Dougherty of Aspect Huntley, in looking past the macro environment, argues that there really should be only two reasons why the average investor should ever sell – because the company they own shares in has changed fundamentally for the worse, or they need cash.
"Obviously if you need cash the best way to get it may be to sell some shares," he says. The challenge is to decide which to sell.
The temptation, says Dougherty, is to sell your best-performing stocks rather than your worst.
"Too many people adopt this approach, and it is a mistake," he says. For one thing it triggers capital gains tax. For another it means you have sold shares that have served you well and which, in the absence of other evidence, are likely to continue to do so.
The better approach, he argues, is to use your need to get cash as a trigger to
review the worst-performing stocks in your portfolio so as to assess which are least likely to improve.
This is a matter of looking at the fundamental business of the company to assess why its shares have under-performed – that is, delivered a lower total return (growth and dividends) than you expected.
In some cases it may be that the share price has recently suffered a setback due to an adverse company announcement. This happened earlier this year to Downer EDI when it announced that a loss on one mining contract had pushed it into the red.
Significantly, this wasn't an automatic signal to sell, particularly since the shares were initially oversold by emotional investors who pushed the price much lower than appeared to be justified.
Rather than responding to just one piece of market news, it is important to look closely to see whether a company in which you hold under-performing shares has suffered more fundamental problems.
You also need to ask yourself why you bought the shares in the first place, and then ask yourself what has changed.
Whatever the reason for a company's under-performance, if you can't see clear evidence that the problem is likely to be addressed effectively, then getting the required cash by offloading your stake in this company is likely to be the most sensible option.
Padley essentially agrees, but stresses that adopting this approach is particularly difficult if it will actually result in a loss.
"Losses have three times the emotional impact of a gain," he argues. "It is three times harder to sell a stock at a loss than at a profit." Despite this it is often the best strategy.
As for profitable shares, both Padley and Dougherty argue that if you don't have a reason to sell then let your profits run.
Points to consider
From Marcus Padley, author of a daily stockmarket newsletter Marcus Today: