selling

From Charles Schwab

Saying goodbye is never easy. But it can be especially tough when it comes to selling your investments. Puzzling out when to take the gains on your winners can be as difficult as knowing when to realize the losses on your losers.

Still, there’s often good reason to let an investment go. It may no longer fit your risk appetite, particularly as you get closer to, say, retirement. Or your winners may have thrown your portfolio out of balance.

Of course, sometimes investments simply go bad — and it’s then that investors may face the greatest difficulty. That’s because four out of five U.S. investors suffer from what behavioral economists call the disposition effect, the tendency to hold on to losers, hoping they’ll somehow recover, rather than lock in a loss.

“Selling magnifies the pain because realizing a loss is tantamount to admitting you made a mistake,” says Mark Riepe, head of the Schwab Center for Financial Research. “But you can compound the issue when you hold on to a losing position for too long.”

That said, reflexively bailing on equities when the broader market turns south is equally ill-advised. “Following the crowd is not a sound selling strategy,” Mark says. “Your decisions should be based on your needs and goals, not everyone else’s.”

So what’s a worthwhile signal when it comes to selling stocks, bonds and funds — and what’s just noise? Here’s what three Schwab experts look for when deciding when to sell an investment.

Considerations for when to sell stocks

If a stock has dropped precipitously while the broader market has not, you should investigate whether the setback is temporary or just getting started, says Steve Greiner, senior vice president of Schwab Equity Ratings.

Check the company’s recent earnings: If it’s consistently falling short or facing unexpected weakness in a core part of its business, the stock could have a difficult time recovering. (A dividend cut is often a clear sell signal, but that typically happens only after earnings have already started to soften — which is generally too late.)

Look for erosion in the company’s balance sheet: Rapidly rising liabilities are a bad sign, because they may indicate that a disproportionate share of the company’s future cash flow will be needed to service debt.

Check analysts’ earnings estimates: “Generally speaking, the less consensus there is among credible analysts’ earnings estimates, the greater the lack of visibility into future earnings, which can set you up for some negative surprises,” Steve says.

Consider external factors: If the stock is dropping but the company’s fundamentals appear sound, some other factor outside the company’s control may be to blame, such as rising oil prices. “You need to ask yourself whether you’d consider selling if that external force weren’t in play,” Steve says. “If the answer is no, you might want to sit tight.”

You might also think about a sale if the stock has significantly appreciated. Steve says every investor should set a price target for individual stocks — consider 30% or more above your purchase price.

The key is to sell when the price hits that target, even if you retain up to half of your position to capture any future growth. Investors often continue to ride a hot position in its entirety in the hope of owning a piece of the next Amazon or Netflix, but few stocks accomplish this feat, Steve says. Many more end up rising to a peak and then losing altitude. “You can find a lot more examples of when you should have gotten out than when you shouldn’t have,” Steve says.

Considerations for when to sell bonds

Price is much less of a factor when considering whether to sell a bond. That’s because bonds often serve a defined purpose in a portfolio — say, generating income on a set schedule. Selling individual bonds before they mature can upset this strategy, particularly if you hold bonds of different durations in a bond ladder that is designed to acquire and retire bonds at regular intervals.

That said, there may be occasions when you want to sell based on changes in the market, says Kathy Jones, senior vice president and chief fixed income strategist at the Schwab Center for Financial Research. “When the creditworthiness of a bond issuer deteriorates, for example, it increases the likelihood of default,” she says.

Keeping tabs on a municipal-bond issuer is fairly straightforward. Reports that an issuer faces financial difficulties are likely to appear in the regular news media, as was the case with the recent problems in Detroit and Puerto Rico. Corporate bonds can be tougher to track in this regard and may require some digging into a company’s earnings and other fundamentals. “All things being equal, you want to keep an eye on debt relative to earnings and make sure there’s enough positive cash flow to cover interest payments,” Kathy says.

You can also look to the credit-rating agencies, which will often put an issuer on a watch list of possible downgrades before actually cutting the rating. “If you can sell the bond before the cut, you can save yourself some money,” Kathy says.

Another reason to consider selling is if you can replace a current bond with one generating a higher coupon. Recent interest rate hikes have created substantial differences in coupons among similar issues, so selling a bond might be the right choice if you can reinvest at a higher rate. “It might make sense to take a loss if you’re going to get a bigger income stream over a substantial period of time,” Kathy says.

Be that as it may, Kathy cautions against trying to time the market by regularly buying and selling individual bonds. “If your bonds are part of a strategy — as they should be — it is generally a good idea to stick with them,” she says.

Finally, you may find yourself holding a bond with which you’re no longer comfortable because you can’t stomach the risk. If you find yourself fretting over an emerging-market or noninvestment-grade bond, for example, the potential gains may not be worth it. “Bonds are supposed to be the part of your portfolio that helps you sleep at night,” Kathy says, “so if they’re a source of constant worry it may be time to find something with less risk.”

Considerations for when to sell funds

When your exchange-traded funds (ETFs) or mutual funds aren’t performing as expected, you could consider looking for a better alternative. “The nice thing about funds is they offer a natural basis for comparison, against either their benchmark index or other funds in the same category,” says Michael Iachini, vice president and head of manager research at Charles Schwab Investment Advisory. “You can almost always find another fund that’s similar to what you own.”

But performance means something different depending on which type of fund you hold. With passive ETFs or index funds, for example, you want the fund to track its underlying index closely. “If it isn’t, then the fund manager is dropping the ball,” Michael says.

The mission of actively managed funds, on the other hand, is to produce better results than their underlying indexes. For example, a large-cap stock fund may look to outperform the S&P 500 Index. Michael cautions that every active manager suffers periods of underperformance, but if the fund is consistently falling short of its benchmark, selling it may be a good idea.

Another away to assess an actively managed fund’s performance is to determine whether it consistently outperforms or underperforms other funds in its Morningstar category.

For comparison’s sake

“You want a fund that consistently falls within the top two quartiles, which indicates it has outperformed at least half its peers,” says Michael Iachini, vice president and head of manager research at Charles Schwab Investment Advisory. “Seeing a long string of performance in the bottom two quartiles, on the other hand, is a sign of chronic underperformance”.

Changes in the way a fund is constructed might be another reason to sell. Sometimes, a passive-fund manager may elect to track a different index, at which point you should be notified and appraise the investment anew.

Actively managed funds switch up their holdings much more frequently, but investors should be wary of managers who change their underlying approach too often. “If they keep changing their stripes, their strategy may not be working,” Michael says.

Cost is a final consideration. That’s less true of passive ETFs and index funds, because fees across the board have been trending lower in recent years, so there might not be much to gain from switching funds on the basis of cost.

Actively managed funds, on the other hand, typically command higher fees — though they may be justified, Michael says, such as when fund managers are doing a deep dive into opaque parts of the market. However, investors should be wary of funds that are increasing their fees in the current environment. “These days, if your fund is raising fees, you can probably find a better option,” Michael says.

Cool and calculated

There are plenty of good reasons to hold on to an investment, even if it’s performing poorly — but reluctance to admit a mistake shouldn’t be one of them.

That’s an argument for periodically taking a fresh look at every investment in your portfolio. And if you can’t be objective about it, consider bringing in an investment professional to help.

“If you’re as disciplined with your selling decisions as you are when adding an investment,” Michael says, “you’ll be far more likely to keep your losses to a minimum and find the best use for your hard-earned money.”

________________

About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.

Additional Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.