10 Questions to Ask Before You Sell a Stock or a Fund

By Damian Davila on 29 February 2016 4 comments

Legendary investor Peter Lynch said it best: "In stocks, as in romance, ease of divorce is not a sound basis for commitment." A clear majority of investors agree that stocks provide the highest average annual return of most common investments, as long as you're willing to hold them for a long period of time (from 1964–2014, U.S. stocks provided a 2,300% return!).

However, there are times that it is indeed worthwhile to bid farewell to a stock. Here are 10 useful questions to ask yourself before you sell a stock or fund.

1. "Why Did You Buy the Stock or Fund?"

Depending on how long ago you acquired the shares, you may not even remember why you bought that stock in the first place. If you call yourself a student of value investing (meaning that you measure the fair value of a stock based on its future earnings power), and you already want to liquidate your holdings after just three months, you're not being consistent with your original investment objective. Most successful investors agree that consistency is essential, so revisit your original reason for buying the stock and determine whether or not it's really time to sell.

2. "What Is Your Risk Tolerance?"

Every investor has an unique approach to wealth management and is comfortable with different price drops. As mentioned earlier, the key is to be consistent and avoid eliminating your positions due to emotions. Remember that the stock market goes up and down. Follow the advice of former Fed Chairman Alan Greenspan: "The market pays a premium to those willing to endure the angst of watching their net worth fluctuate beyond what Wall Streeters call the 'sleeping point.'" (See also: 3 Pearls of Financial Wisdom From Alan Greenspan)

3. "How Is the Investment Performing Against Its Benchmark?"

Learning that the price of your stock dropped 3% may make you nervous, but finding out that its benchmark dropped 6% over the same period puts things in perspective. Just like having an investment strategy and determining your risk tolerance, establishing a benchmark is essential to evaluate the performance of any investment. Financial advisers often suggest using an exchange-traded fund (ETF) that tracks an index, such as the S&P 500 or the Russell 2000 as a benchmark. Depending on the sector of your stock, other ETFs or indices may be more appropriate. For mutual funds, consider reviewing the Lipper Indexes of funds with a similar investment style.

4. "What Is the Weight of a Stock or Fund in Your Portfolio?"

Don't sweat the small stuff! It's one thing if that your stock represents 2% of your entire portfolio, and quite another if it's 60% of your portfolio. If you did your due diligence, you selected a variety of investments so that the positive performance of some investments neutralizes the negative performance of other investments. Putting all of your eggs in one basket is never a good idea when it comes to investing, especially with your nest egg.

5. "Do the Shares Have a Vesting Period?"

In the event that you're thinking about selling stock that you received as part of an annual bonus, you may be out of luck. For example, your employer could have awarded 250 restricted stock units that vest over time, such as 50 units every year for the next five years. If you're on the third year out of those five, you may be able to sell 150 out of those 250 shares. To find out the vesting period and the list of applicable rules of your company stock, contact your HR department.

6. "What Is the Total Transaction Cost of the Sale?"

Remember to include all applicable fees in your transaction cost calculations. Among the many sneaky 401K fees to watch for, the back-end load (also known as redemption fee, exit fee, or contingent deferred sales charge) is the one that you have to pay attention to during the sale of mutual funds. While you can technically sell your shares of a mutual fund right after having loaded them into your portfolio, you may have to pay an extra fee by not holding the shares a minimum period. Back-end loads range from 0.01% to 2% and are triggered by sales within 65 days, on the average.

7. "What Is the New Asset Mix?"

The sale of shares may dramatically affect the asset mix of your portfolio. For the long-term retirement savings of young investors, most financial advisers recommend allocating 90% of funds to stocks and 10% to bonds. Under this scenario, by selling a large holding in your portfolio, you may decrease your stock allocation significantly! To get your asset mix back on target, you would need to exchange the old stock or mutual funds shares for some new ones. If you're planning to exchange shares within the available options of a 401K plan or investment account, watch for potentially applicable sneaky investment fees, including exchange fees and front-end loads.

8. "Do You Keep Your Current Schedule of Charges?"

On the other hand, if you decide to liquidate your holdings and cash out entirely out of your portfolio, beware the ranges of the schedule of charges of your investment account. By reducing the size of your investment portfolio, you may forfeit benefits such as reduced fees and expenses. When cashing out is a must, your financial institution could allow you to keep your current schedule of charges by signing a letter of intent to reach that threshold again within a specific period of time.

9. "What Are the Tax Consequences of the Sale?"

On top of any associated fees from liquidating your shares, you also face applicable income taxes on capital gains. The IRS treats capital gains from the sale of shares held for less than a year as ordinary income, but provides a tax break on sales of shares held longer — typically a 15% tax rate. And if you make the mistake of taking a distribution from your retirement account for the amount of the sale before age 59 1/2, you would trigger an additional 10% early distribution penalty.

In the event of a capital loss, remember that you have to follow the IRS' "wash-sale rule" to be able to claim the loss for tax purposes. The rules state that you can't buy the same or "substantially identical" security within 30 calendar days before or after the sale.

10. "What Is the Opportunity Cost of the Sale?"

While you shouldn't become a victim of paralysis-by-analysis by overthinking too many "what ifs," make sure to consider the opportunity costs of liquidating your stock or mutual holding shares.

For example, for individuals younger than 50, the annual contribution limits to a 401K plan and IRA are $18,000 and $5,500, respectively for both 2015 and 2016. Let's assume that you are age 40, plan to retire at age 65, and have an expected rate of return of 6% for your IRA. If you were to liquidate an entire $5,500 from your Roth IRA, you would forfeit an extra $23,605 of income at age 65.

By figuring out the opportunity cost before you sell a stock or fund, you begin to understand why Warren Buffett's favorite holding period is forever.

What are other questions to ask before you sell a stock or fund?

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Kimmy Burgess

It is true that many small & bigger things needs to be recalled before selling any stock. But patience & accuracy does plays a major role in getting to the depth of it.

Damian Davila's picture

Patience goes a long way in investing. Economist Paul Samuelson said it best, "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas".

Guest's picture

Great Information about stock market.

Damian Davila's picture

You're welcome!