The best time to invest is today and the second best time is tomorrow.
That’s true for investing, deciding when to start working out, quitting a nasty habit, and many other life goals.
It’s tricky to figure out what to invest in but there are a number of easy options such as diversified exchange traded funds (ETFs) to help get you started.
However, deciding when to close a position or get out of an investment can be much more difficult. There of course should be a reason behind the decision to sell a stock. Maybe the stock isn’t performing and you don’t expect that to change anytime soon. Or perhaps you just need a little extra cash at the moment. Choosing when to sell a stock is very dependent on personal situations but there are some general guidelines that can be followed to make sure you aren’t selling the dip.
“We Like the Stock”
If you like the stock, then don’t sell it. Sure maybe you're betting on the wrong horse but if you truly believe the stock and underlying company are bound for future success, don’t sell without a really good reason. Depending on what your goals are or methods for picking stocks, these signals can be different for when not to “like a stock”.
Closing a position that you believe has reached its peak or is bound to underperform relative to the market going forward is smart but it's hard to know when that time comes. For a value investor it may be when that stock has reached a fair value or even starts to look overvalued. Growth investors should look for signals that a firm has far less room to expand or is being outshined by competitors with stronger products and services. Meanwhile, sentiment traders may simply look to see when the push for GameStop (GME), Dogecoin (DOGE), Bed Bath & Beyond (BBBY), or other meme investments die down as new money stops flowing in.
If an investment is no longer suited to your investment goals, then it's time to find one that is.
Tax Implications
Closing positions and opening new ones is already a difficult task but taking money out of the market overall can be even more challenging. Trying to “time” the market and pull out before a bearish run is next to impossible and usually just results in missing gains. Investing is a long-term game and the longer assets stay in the market, the larger the returns as the history of the S&P 500 proves. There are certainly times in the business cycle where investors will want to reallocate their assets to more defensive stocks, but when actually taking money out of a portfolio a huge factor is taxes.
Short-term investments, those held for less than one year, are taxed at the same rate as ordinary income. Meanwhile, gains on positions held for more than a year are taxed at either 0%, 15%, or 20% with 15% being the most common. Given that ordinary income is taxed up to 37% depending on your tax bracket, there are huge benefits to holding an investment for at least a year if possible. There are certain situations where holding on to a stock just to have it for a year won’t be worth it. Again relating to if an investment doesn’t meet your goals or simply has a bearish outlook, then selling early outweighs any tax benefit. There’s little reason to hold GME stock for over a year if the only reason is tax benefits and not some “diamond hands” investor mentality.
Minimize Taxes
The best way to capitalize on tax benefits though when selling stocks for an immediate return of capital is offsetting gains and losses. It can be tough to decide which stocks to sell when you just need some cash. Traders have to weigh selling winners that may underperform going forward versus losers that may finally bounce back. It’s tough to sell a stock that didn’t meet expectations only to see that same stock skyrocket after you’ve sold.
Just as when investors are building out their portfolios, diversity is key when selling as well. Keeping your stocks balanced across sectors and industries is important and having capital gains and losses cancel each other out can also be a factor. Offsetting stocks that have positive gains and ones that have fallen since you’ve opened the position can minimize your tax bill. Balancing out winners and losers has no small impact. We're talking about having to pay between 15% and 37% of your gains, so avoiding taxes can be a big benefit if done correctly.
Wrapping Up
Historical performance does not indicate future results. Winners won’t always win and losers may finally recover and outperform. Diversification can be a factor when buying stocks and it's the same case when selling. Keeping a balanced portfolio of investments that you like and believe will help reach your investment goals is paramount. Additionally, taxes are an extremely complicated and annoying part of life and investing but should be of central importance when discussing which assets to hold or sell. Handing over more money than necessary to the IRS may be virtuous in some way if the government uses that money wisely (big if), but isn’t exactly desirable in strictly financial terms. Keep the stocks you like and sell the ones you don’t, with a goal of minimizing taxes paid as well.
