Selling the winners

We discussed selling an investment that is down on its luck. Today I want to talk about selling your winners. Of course, there are three things that you will say which will keep you from selling your winners:

“It will keep going up.” It’s hard to argue with that. You may have found the stock of the decade. Besides, it’s a fact that a rising stock has a tendency to keep rising.

“If I sell it, I’ll have to pay taxes on the gain.” True (unless it’s held in an IRA or other tax-qualified account). Even worse, if you’ve held it less than a year you would even miss out on the benefit of the long-term capital gain taxation rates.

“I’ve heard that buy-and-hold is the best way to make money in the markets.” I’m not sure it’s the best way, but it is generally a good idea since the average stock goes up every year.

Okay, those are three reasons—reasonable reasons—why you may not want to sell a stock that has soared. Consider all of them before you sell a stock, fund, or other security that you own which has been doing well over the years. But I can’t stop the column here. It would be too short and I’d get in trouble.

So I’d like you to consider an argument for selling off some of your winners: If you don’t you’ll be out of balance.

Professional money managers are very concerned with balance in a portfolio. That’s because any market, asset type, or sector can go down and stay down for an extended period of time. In order to prevent the portfolio’s performance from being tied to a single market, sector, or security, they’ll spread out the wealth and diversify.

Even so, something is going to do really well. If this happens for an extended period of time, that part of the portfolio grows to dominate its performance. For an example, think of the stock market as a whole and tech stocks in particular during the last half of the 1990s. If you had let your money ride on the tech winners, you would have seen a dramatic hurt put on your portfolio.

To prevent this, rebalancing is necessary: selling off some of what is now overweight and buying up some of the underweight issues. Doing so results in you selling off some of your winners. (Exactly how to figure out how much, which, and when is what all portfolio managers in the world are trying to get right.)

Therefore, even in the face of upward momentum, the specter of taxes waiting in the wings, and the general buy-and-hold philosophy, sometimes it does make sense to sell down your winners. It will help you win again.

This article was published under the title "A case for selling winning stocks" in the Wichita Falls Times Record News on June 24, 2012.