The best time to sell a share

MANY of us have an innate weakness when it comes to buying things. It might be subconscious, but it’s lurking there in the back of our minds. We hanker for assurance. We want to know that we have made the right decision when we, say, buy a house or a car. We want to know that we have made the right choice when we buy new clothes or acquire a share.

It is only natural to seek assurance. Similarly, we might start to have doubts when we hear major shareholders in companies that we are invested in have decided to dispose of their shares. What could they possibly know that we don’t? Did the person see something that we may have missed in our analyses?

It is possible that we might have overlooked something. But investors sell shares for a variety of reasons. It is not always because they think something terrible is about to happen. So, when should we sell shares? As for me, I never sell shares. I am not just a long-term investor, but I am also a committed buy-and-hold investor. There are very few reasons that would make me want to dispose of a share.

Reasons 1, 2 and 3

Some might disagree with that rigid investing philosophy. So, here are a few reasons why and when it might make sense to sell a share. The first reason is when we are in need of cash. For instance, we might have been investing for a specific reason, such as for our children’s school fees or for retirement. When the time comes to pay those fees or when we choose to stop work, we may consider selling our investment. Isn’t that why we invested our money in the first place?

Another reason to sell a share is when we might have found better opportunities elsewhere. As investors, we should be mindful of opportunity costs. In other words, we should be aware of the cost of holding an investment compared to holding something else. Most of us don’t have unlimited pools of money. So, if we put our money into one business, then it is unlikely that we can afford to invest in something else.

A third reason to sell is when there has been a change in the investment thesis. Consequently, if we have invested in a business that, for whatever reason, has changed direction, then we might want to revisit our reasons for investing. If we are no longer comfortable with the reasons to continue to hold the shares, then we might consider selling.

Reasons 4 and 5

The fourth reason to sell a share is to diversify. Diversification can mean different things to different people. Some investors may want to weight their portfolios by sector; some may weight them by geography. Others may simply weight them by value alone. So, if a particular investment has become too dominant, then we may consider selling some to reduce our exposure. It can be a good way to reduce risk. A less drastic way could be to simply add more money to other parts of the portfolio.

The final reason to sell an investment could be valuation. If we believe that an investment has become too expensive, then we may want to sell it to capitalise on a possible mispricing by the market. But before we pull the trigger, it is important to differentiate a high-share price and an expensive valuation. They are not the same thing.

Buy-to-hold perspective

From a buy-to-hold perspective, though, none of those reasons are ever good enough to sell a share. Firstly, we should not need to sell shares to realise the cash we need for our expenses if we focus on dividend generation. This strategy does require planning ahead of time to ensure the portfolio is robust enough to deliver the rising dividends we need.

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What about finding better opportunities for our money? When we first invest in a company, we should be looking at a business with solid fundamentals. We should also be looking for companies with a strong management team that has a proven track record of generating profit from sales. If nothing fundamentally has changed, then there is little reason to jump ship.

However, if a company has changed direction completely, and even changed its name in the process, then everything changes. It is no longer the same company that we invested in originally. Peter Lynch once quipped “Corporations, like people, change their names for one of two reasons: Either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.”

The writer is co-founder of The Smart Investor.