One of the most important aspects of investing is knowing when to sell. In fact, knowing when to sell can be as important as knowing when to buy.
Knowing when to sell is tricky, since you have to take into account whether or not you think the investment has future growth potential. You have to determine whether you think that the investment can recover from its current funk--or if the investment is in a bubble and you should sell before the price plunges.
You don't want to sell willy-nilly, but there are times when it makes sense. Here are three good reasons to get rid of something:
1. The Fundamentals Have Changed for the Worse
Why did you buy the investment in the first place? What made it attractive? Now, look at the fundamentals. Have those items changed. If an investment still has the same solid earnings growth or soaring sales you were impressed with initially, there is a good chance that the investment will recover from its current problems.
If, however, something has changed about the fundamentals, that can be a good reason to sell. Look at the underpinnings of the investment. If there has been a radical shift that threatens to create problems, you need to seriously consider selling.
2. The Investment Outperforms Similar Investments
Is your commodity investment leaving other commodities in the dust? Are you seeing a company stock shoot much higher than others in its sector? If your investment is suddenly seeing a great deal of growth relative to similar investments, it could be a warning sign that a pullback could be in the near future.
You can also see this in dividend stocks that have much higher yields than other dividend-paying stocks in the same industry, or in a foreign government's bond whose yield suddenly heads higher than similar countries' yields. While you want an investment that has the potential to outperform over time, a dramatic increase in value relative to similar investments can be a good reason to sell now, before the bubble bursts.
Similarly, be wary of investments that are dramatically underperforming their peers. While you can get some good deals by choosing underperformers, you are walking a fine line. If your investment starts to drop in value, and if it is approaching a stop loss you might have, or if it is dropping more than similar investments, that could be a red flag.
3. It No Longer Fits Your Goals
You should have an investment strategy that takes into account the composition of your portfolio. If an investment no longer fits your goals, it's probably a good time to sell. If you are rebalancing your portfolio, look for a way to replace an investment that no longer fits with an investment that is more likely to help you reach your goals--and do it more cost-efficiently.
Don't forget to evaluate your investments according to how much they are costing you as well as how well they fit into your overall plan. You might be able to find a fund that serves the same purpose--but has a lower expense ratio--than a current investment in your portfolio.
Your portfolio requires a holistic approach. Every so often, take the time to evaluate your investments, and how they fit into your portfolio. Look for investments that you might have good reason to sell, and get rid of them. If you know that there is a good reason to sell a particular investment, do so. Don't wait until your portfolio is in peril.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.