Selling Smart

Selling Smart

"Flying isn't the hard part; landing in the net is." - Mario Zacchini, one of the original "Flying Cannonballs"

How do you stave off emotion and make good, sensible "sell" decisions?

The same way that you keep emotion at bay when deciding what stocks to buy: By using a disciplined system that makes sell decisions based on cold, hard fundamentals - not emotion-driven hunches, or arbitrary price targets.

To sell smart, you have to go back to the basic premise behind our "buy" strategy. And that is that over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time. We buy because of the fundamentals - not just because the price is high or low or rising or falling. Remember, the only way price comes into the decision to buy is in how it relates to the stock's fundamentals - that is, in the form of such variables as the price-sales ratio or price-earnings ratio.

When you're building your portfolio, you want to pick the stocks that have the best fundamentals - because over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.

What does this have to do with selling stocks?

If you're buying stocks because they have strong fundamentals, and over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.

Whether the stock has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand RIGHT NOW. Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stocks P/E or P/S ratios are, for example).

Many investors will sell a stock because its price has fallen and they think they need to cut their losses, or because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down.

But those are arbitrary, emotional decisions. Remember, you bought the stock because its strong fundamentals make it a good bet to gain value; if its fundamentals are still strong, why wouldn't it still be a good bet to gain more value?

If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria (and one that thereby has better prospects of rising in value).

The selling assessment is thus an ongoing reevalution of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.

Whether you use a one-month rebalancing or a different time frame that works for you, the important point is - you need to re-examine your portfolio at set intervals, to assess how your holding stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.

You can also use your rebalancing period to reweight your portfolio in case some of your holdings have gained or lost a bunch, and now make up a disproportionate part of your portfolio. The idea here is to keep things close to equally weighted. It doesn't have to be perfect, though; if one stock gains a little ground so that it makes up a few more percentage points of your portfolio than the other stocks, you don't need to go selling a couple shares - and getting hit with trading charges - just to even things out exactly.

To keep this simple, you might want to set a reweighting target percentage. For example, anytime a holding's weight in your portfolio becomes 10 percent more or less than your target weight, you buy or sell shares of it to bring it back to that target.

By sticking to a firm rebalancing plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.

When do You need to Sell Urgently?

There are a couple rare occasions, however, when you should sell a stock without waiting for the rebalancing date to arrive.

• If a firm is involved or allegedly involved in a major accounting or earnings scandal, you should sell the stock immediately, because you can no longer trust its publicly disclosed financial data.
  
• In addition, if a firm has become a serious bankruptcy risk since the last rebalancing, you should also sell its stock immediately.