Discussions about investing typically focus on what and when to buy. But when to sell an investment is also an important consideration. Mark runs through how you know when to sell an investment. 

Additional resources:

Article: When should you sell shares? Plenty of people will tell you what to buy but few weigh in on when to sell.

Tool: Tax calculators: Moneysmart and ATO

Proceed to Module 9: How to set yourself up for investing success: Course conclusion

Shani Jayamanne and Mark LaMonica, CFA provide a summary for the course and where investors should go from here.

Back to course outline. 

Module transcript

Mark LaMonica: In the last module, we talked about monitoring and maintaining your portfolio. But now we want to talk about what happens when you actually sell individual investments. Because as much as we are proponents of being long-term investors, we know there are going to be times when you need to adjust your portfolio, or you want to adjust your portfolio.

So, let's take a step back and talk about selling. We hear as investors all the time two different things. The first thing is we hear a lot about investment opportunities, about these can't-miss shares or ETFs or funds that we should invest in. The other thing that we hear all the time is that we need to change our portfolio and adjust our portfolio based on market conditions. So, let's go through these two reasons and these are often reasons why investors will choose to sell something. Let's go through these two reasons and talk about some of the pitfalls and whether this is applicable to most investors and whether this helps you achieve the success that you want and that's of course achieving your goal.

So, first, let's talk about this can't-miss opportunity that get pitched at you all the time. So, you'll hear these from a couple of different sources. You will of course hear these from the financial media. You will hear a portfolio manager go out there and talk about a great opportunity and a share. You will hear this from your mates as well. They'll tell you about an investment they're in that has performed really well and that you need to invest in. And this really kicks off greed. And investing is a lot about emotion, and we've talked a lot about emotion throughout this entire course. But investors are driven by greed, and they're driven by fear. So, both of these two ways that you're getting these pitches about opportunities from professional investors and also from your mates, you have to realize that both of them have no context into what you're trying to accomplish. And we spent a lot of time talking about how this is all about you and what you want to accomplish.

So, let's start with investment professionals. So, they of course spend all of their time monitoring the markets. They have potentially large research departments that are working with them. And when they go out there and they're pitching certain ideas, remember that they're either pitching that because they are paid to pitch that and that their firm gets some benefit if you invest in this great new ETF or fund where they're trying to attract new clients, or they get the benefit of course if there's something in their portfolio of trying to convince other investors to buy that which of course in the aggregate will make that go up if enough people are buying into that investment. And remember that a lot of these professionals are very, very savvy at pitching ideas. They've spent their whole career pitching those ideas. They have marketing departments behind them that are helping them make as compelling as of a pitch as possible. And then your mates, if they're pitching ideas to you, they also don't know the context with which you're investing. They don't know how this would fit into your overall portfolio. So, if you're thinking of selling an investment to take advantage of a better opportunity, think through what needs to happen for this to actually turn out to be good for your overall portfolio.

So, the first thing that has to happen is of course the investment that you put your money into needs to be better than the investment you sold. And we talked earlier about that study from Cal-Berkeley that shows for the most part investors get this wrong. And there is a real reason for this, and it's called reversion to the mean. And reversion to the mean is simply the concept that certain investments that outperform over short periods of time, their performance will eventually come back closer to the average. So, it's very difficult for something to outperform all of the time. So, when you're chasing that performance, you're often getting in too late after something has performed well and it will have below-average performance going forward. So, that's one thing we need to worry about and certainly illustrated in that Cal-Berkeley study.

The other thing that we've been trying to talk about over and over again is of course all the costs associated with it. So, there's certainly those transaction costs, so what you're paying for brokerage and then that buy-sell spread that's on most investments. But there's also the concept of taxes which can be a huge detriment to you as an investor.

So, let's use a simple example. So, in Australia, you pay your marginal tax rate on capital gains, and we'll talk through some of the specifics about this. But let's say you're in the 32.5% marginal tax rate bracket. And if you purchased a share for $10,000 that's appreciated to $15,000, you then have a capital gain of $5,000. If you sell this within a year of owning it, you are going to pay that full marginal tax rate on that capital gain you've made. So, basically, on that $5,000 you're going to owe $1,625. So, you have to pay that to the government. And that is over 10% of the proceeds that you got. So, 10% of that $15,000 in proceeds you got back. So, the first thing that needs to happen is that new investment that you've purchased needs to outperform the old investment you sold by at least 10% even to get you going back to even. Now, if you've held it for longer than a year, you do get a tax break on that. So, you get a 50% tax break, which means that that $1,625 gets split in half. But that's still 5% of that total capital that you've gotten from selling that position. So, meaning you still need to outperform the old investment by 5% just to get back to even. So just be very wary of all of these pitches that you're getting, all of these opportunities that people talk about.

The next thing we hear that we talked about earlier is that there is this notion that savvy investors are always keeping up with the market, keeping up with the overall economy and they're adjusting their portfolio accordingly. And this is another reason why investors tend to buy and sell all the time. They have lots of transactions, they churn through their portfolio. And we have to think about what it actually is that drives markets. So, markets are forward looking. And what that means is it doesn't really matter what happened in the past. Market cares about what's happening in the future. But of course, the future is unknowable and investor expectations about the future are changing all of the time. So, if investor expectations are driving share prices, then we have to think about are those expectations actually realistic and what happens if you meet those expectations, exceed those expectations or don't meet those expectations.

So, let's go through a couple of examples. And COVID-19 is a really good example to look at how the market is forward-looking. And we can talk about how those expectations change. So, if we remember going into 2020, we saw a pretty significant fall in the market once people started to wrap their heads around what COVID was. And the market got very worried. So, this is where fear comes into play and there was this large sell-off. But of course, fairly quickly, even as COVID was still impacting the economy significantly, even as it was still spreading, we saw the market recover. And that's because investors got comfortable with the fact that there would be temporary changes to the economy that were very negative for companies, but that it would be temporary, and it would go away, and they were starting to look past COVID. And then we saw that market rebound.

So, what we're really talking about here is expectations. We're talking about the consensus expectations of all different market participants. So, in order for you to be savvy enough to move your portfolio around, you need to have different expectations than most of the market. So, you either need to think that the consensus expectation is wrong, or you need to be earlier than every other market participant. And this is very difficult to do. So, there are professional investors who are paid a lot of money, who spend all of their time monitoring the economy, monitoring the market, and most professional investors fail to beat the index. So, they fail to exceed the average return that investors get. So, you need to be very confident that you're able to do this.

And in an earlier module, we talked about edge and the concept of edge. And really, that's just, of course, what do you think is going to allow you to make better decisions than other investors out there. And if you think that you can be savvy enough to move your portfolio around as the economy changes, you really are saying that you have either informational edge or analytical edge. Those are two of the hardest things for investors to have. And as I said, many professional investors who are trying to gain that edge or competitive advantage fail at doing that. And really, as we talked about before, your advantage as an investor is that behavioral edge, don't do stupid things, don't let your emotions take over. And of course, the edge that you have by being long-term investors. And both of those, you are actually going to detract from if you're constantly trading. So, while some people can be savvy enough to move their portfolio around based on market conditions, it's very, very rare. So, you need to be very confident that you're somebody to do that if you're going to take that approach to selling investments in your portfolio.

So now that we've gone through a couple of pitfalls and some of the common things that investors do when they're trying to sell investments, let's talk about what you should do. So, as we said over and over again, we're trying to build structure into your decision-making. That's why we started with goals. That's why we have a set asset allocation. That's why we documented our investment strategy in our IPS. So very simply, if an investment has changed – and we'll go through a couple of examples of that – but if an investment no longer fits into that strategy, that might be a good opportunity for you to sell. And the other thing when you're buying and selling investments, we've encouraged you to write down the reasons you're doing it. And that can play a part as well. So, if you're going to sell something in your portfolio, make sure that it's something that no longer aligns to your strategy.

So, let's use an example. Let's say you've defined a strategy of buying income-generating shares, so shares that pay dividends and that grow those dividends over time. Well, in some cases, of course, companies run into trouble. They have to cut their dividend. So, if you're trying to find a dividend that has stability and growth involved and a company cuts its dividend completely back to zero, that might be a reason why it no longer fits into your portfolio. And of course, when they cut their dividend, there is going to be an impact on the price, a generally fairly negative impact on the price, but that security no longer fits into your strategy. So, it's a good candidate to exchange for something else that does fit into your strategy.

And then the last thing, of course, and another reason why you want to sell is you want to start funding your goals. So, whether that's retirement, you need to sell off portions of your portfolio in order to fund your lifestyle, whether you've reached the point where you need a lump sum out of your portfolio in order to pay for a goal, you can sell then as well. But you once again want to take all of the different things we talked about into account. You want to minimize taxes. So that's potentially selling investments that have not appreciated in value so that you don't have those capital gains taxes to pay. You want to minimize those transaction costs. Make sure you are selling those investments at the right time. And that can be important in the case of an ETF. And just going through and making sure that you checked all those boxes to minimize anything that's going to detract from your overall returns. So, certainly, as an investor, you are going to sell things out of your portfolio, especially over the long term. But make sure you have structure around it, make sure you go back and refer to the strategy that you're trying to execute and make sure that there is a very high hurdle rate before you sell things.

So, obviously, going back and looking at your strategy is important. But the other thing we do need to talk about, of course, is the emotions as markets go up and down. So that volatility. And remember, volatility is something that is going to happen. There are going to be down years in the market, but it does elicit a lot of emotions. So, let's talk about what you can do when the market is going down significantly. Many investors reflexively want to sell at that point. And we have to understand that if you have not experienced a bear market, that it's very difficult. It's, of course, being covered in the media. There's a very pessimistic view out there that things will not change. You are potentially getting questions from your partner, from your mates. And of course, there's pressure building on you when you start looking at your portfolio and seeing that number tick down and down and down. And this is very, very difficult to resist. These emotions are very, very difficult to resist. And this behavioral edge that we talked about does take a lot of discipline in order to take advantage of. So, there's a couple of things you can do when you're feeling a lot of pressure, when that fear is overtaking the rationality of your thought. Go back through, look at your plan. Remember that ultimately as difficult as it is to not react to volatility in your portfolio, that you need to maintain discipline in order to achieve your goals. And as I said, that's not easy, but being a successful investor is not easy either.

So just remember that the sacrifice you're making and the discipline that you're showing is what it's going to take to get you where you want to be and get the future that you want.