Four reasons why you should sell, and one reason why you shouldn't.
A whopping 80% of the shares in the FTSE 100 are in positive territory this year. The shares of companies like Barclays (LSE: BARC), Rentokil Initial (LSE: RTO) and Fresnillo (LSE: FRES) have all more than doubled this year. And it's not like these are some tiny micro caps -- these are all multi-billion pound companies!
Which means it might be time to take some money off the table.
But knowing when -- and how -- to sell is one of the most difficult investing decisions you have to face. It's much more difficult than deciding whether to buy a particular share.
But just ahead, I'll outline four key criteria you should use when determining whether you should sell a share, and then spell out two different ways to do so. But first, let's look at why it's so tough to let go.
Breaking Up Is Hard To Do
Cognitive dissonance makes us uncomfortable. Really uncomfortable.
Cognitive dissonance is that feeling you get when you know you shouldn't do something, but you also know that it feels damn good.
It's the feeling you get when deciding whether or not to order the Double Whopper with cheese and fries. It's also the feeling you get when you're up 100% on a share that you were once down 50% on. You swore you'd sell when you broke even, but now you're thinking of holding on for another 100%, or maybe another 200% ... on second thought, maybe you'll just wait and see where you are six months from now.
If you've ever been in that last scenario (if you're like me, you're probably going through that process with your portfolio right now), it's a good idea to have hard-set rules for when to sell a share. That way your easily swayed emotions don't get the best of you when it really is time to move on.
Here are four criteria that you should use when determining whether or not to sell.
1. Better opportunities
Whether you're up, down, or at break-even with a share in your portfolio, if you come across a more attractive opportunity, you should seize it.
What qualifies as a more attractive opportunity? Two things: A share that's more undervalued than a current holding, or a share that's valued about the same, but has a lower level of risk.
For example, let's say you own a small-cap stock like Salamander Energy (LSE: SMDR), and you're up over 200%. You think it still might be about 10% undervalued. But you also have been looking at BP (LSE: BP), which you think could be as much as 20% undervalued. At this point, it would make sense to take your already high gains on Salamander Energy and snap up shares of BP.
2. Valuation
It's a smart move to have some rules in place regarding a company's valuation. ARM Holdings (LSE: ARM) might have seemed a reasonable investment back at the start of the year when it was trading for at its recent 52-week low, when it was trading for around 16 times earnings.
But now that it's trading for around 30 times earnings, it's not nearly as attractive, and might be overvalued. If you have an undervalued company you've been eyeing, it'd be best to sell ARM and buy it instead.
3. The business changes
There's only so much you, as an outsider, can know about a company. Most day-to-day business is out of your control. Take Royal Bank of Scotland (LSE: RBS) for example. After the sub-prime crisis first broke, back in July last year, you might have questioned whether RBS could weather the storm, especially coming so soon after they'd paid top dollar for ABN Amro. Expectations for the future were suddenly vastly different, and you'd have been best to take your losses or gains and move on.
4. Wrong investment thesis
When you're looking for companies, you want to find ones that are undervalued and that have a strong catalyst for growth. If your thesis for investing in a company was a potential growth opportunity in China, and then it comes to light that the company is scuttling plans to enter that international market, your thesis is invalid. It's tough to admit that you were wrong, but it's best to humbly admit your error and move on to better opportunities.
Just Letting Go
When you are ready to sell, you can either do so gradually, or do so completely. When it's a valuation issue, it's usually best to move out of the position gradually, in case the share still has more near-term upside. But when the business radically changes, your investment thesis is wrong, or you see a clearly better opportunity, selling in one fell swoop is often the best move.
Finally, there's one reason not to sell. It's never best to sell just because you think the stock market may fall. With the market currently in downward tend, it's a salient reminder.
More on the economy and the markets:
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> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson, who doesn't have an interest in any of the companies mentioned in this article.
