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March 20, 2000
That is the number one question going through each investor's head when a highflying stock market starts heading south. Many successful investors say that although it is important to time your "buys", it is much more crucial to time your "sells" – it can be the difference between making a lot of money or losing your skirt. So before you click on that "sell" button carefully consider these factors:
- Why are you selling?
- Long term capital gains vs. short term capital gains
- Re-entry point
Why are you selling?
It is natural to want to sell when the market starts going down and we see our hard-earned profits melt away. However, it is important not to sell a great stock prematurely or you may miss out on some huge future gains. As a long term investor, your objective is to purchase stocks in solid, well run growth companies early on and reap the benefits as it appreciates in value, hopefully for years to come. If you have chosen wisely there is no need to sell the stock unless the company's growth slows down, management can't successfully execute its business strategy or their product loses its competitive edge. It is tough to time the market (know when to jump in and jump out). We only know that the stock market will go up sometimes, go down sometimes and trade sideways sometimes. So don't let the market control you. You decide when to buy or sell a stock. Evaluate the fundamentals of the company. Are they still firing on all cylinders? If they are, it may be ok to ride out the dip in the market. Evaluate your current cash flow needs. Were you planning to sell some stocks in the near future to purchase a car, a house, pay down your mortgage or any other large purchase? Then maybe you should sell now and secure your profits just in case the market stays in a downward trend. It is better to have the money early than to chance not having it when you need it. And last but not least, evaluate your investment strategy. Has your stock fallen to key support levels? The secret to a successful selling strategy is to establish your exit points in ADVANCE. If your stock has fallen to that point, either based on amount of minimum profit or maximum loss you're willing to accept, it is time to sell. Selling a stock should not be an emotional decision, just because everyone else is panicking, it should be based on executing well thought out investment strategies.
Long term capital gains vs. short term capital gains
There are two holding periods for calculating capital gains or losses: 1) capital assets held for one year or less are considered short term and are taxed at your normal tax rate, 2) capital assets held for more than one year are considered long term and receive a reduced tax rate of 10% for taxpayers in the 15% tax bracket or 20% for taxpayers in the 28% or higher tax bracket. The holding period is based on the "trade date" and not the "settlement date" of your stock transaction.
Although your tax situation is not as important as following your investment strategy, it can still substantially effect your bottom line earnings if you are in the top tax bracket. For example, if you hold a security for longer than one year, you'll probably pay 20% of your gains in taxes (Alternative Minimum Tax may effect your tax rate). If you hold a stock for less than one year, you'll pay as much as 39.6% (1999 tax year) of your gains in taxes. If you report a gain of $3,000, that is a difference of $588 or 19.6%. To justify a short term trade, you'll need to squeeze out an extra 20% to make it worthwhile.
Re-entry point
Aah, this is the tough one we investors always struggle with every time we exit a good stock. When do you buy back in? If you jump in too early, the stock keeps falling and when you jump in too late, you miss out on the profit run. If you like the company for the long term, but you need to exit because the stock has fallen too low, remember to identify your re-entry point or you will keep struggling with the decision as the stock keeps moving up until it runs up too much – a very common mistake.
As a successful investor, your investment strategy must be based on your own unique financial situation, not the whimsical ups and downs of the stock market. It takes discipline to stick to your strategy when everyone else is screaming "the sky is falling!". Learn to tune out all the noise and focus in on key indicators of the stock market and your investments -- you will be well on your way to sizable investment portfolio you can be proud of.
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