Updated: Jul 12
I often peruse Google Trends just to see what’s on people’s minds. I believe it’s important to remain current, but it also helps our company better guide investors as we learn what they’re thinking but don’t always say. What I noticed in this recent trend is shocking, but not surprising.
Now look at the 5-year chart of the CAPE Ratio (Cyclically Adjusted Price-to-Earnings) of the S&P 500 which measures the price to earnings ratio for large-cap domestic stocks and adjusts for inflation. In other words, it shows how high or low companies are valued relative to the money they earn.
The stark difference between these two charts is fascinating and speaks volumes on investor psychology. Notice the drop in CAPE Ratio (meaning stock prices fell more than their 10-year inflation-adjusted earnings) down to around 25 in early 2020 when COVID-19 thrashed its way through the economy and sank the market. Now look at the spike in google search results for "should I sell my stocks" which coincided right around the same time stocks were selling off. I guess the old adage "buy low, sell high" fell on deaf ears.
Granted, the degree of uncertainty was high in March 2020 as the world hadn't prepared for, or experienced anything quite like the coronavirus. So I can see why this black swan event drove frightened investors to ask google if they should sell out of the market. The sad part is, most of them did.
According to data from Fidelity, one out of three investors over the age of 65 sold all their stocks sometime between February and May of 2020. Yes, I said ALL!
When stocks fall like they did early in 2020, people fear those losses will continue which pushes them to sell low and avoid further damage. Conversely, a rising market like the one we're currently in stimulates FOMO (Fear Of Missing Out) which in turn leads to buying when prices are inflated.
In light of the S&P 500 trading near all-time highs, propped up by zero interest rates and trillions in stimulus money, I thought it prudent to revisit the "should I sell my stocks" query and offer a guide designed to help investors determine when it makes sense to sell and help them avoid pulling the trigger for the wrong reasons.
The 5 Instances it Makes Sense to SELL Stocks
Buying stocks or bonds when they're down and selling when they're up simply describes the process of portfolio rebalancing. It's a disciplined strategy designed to ensure your investments consistently and accurately reflect your current level of risk and financial objectives.
For example, when the market fell 34% in March 2020, a portfolio with an 80/20 mix of stocks and bonds may have shifted to 69/31. Instead of selling stocks like most investors did, rebalancing would involve buying stocks using proceeds from the sale of bonds to rebalance the portfolio back to the initial target of 80/20.
Helpful Hint: Consider rebalancing your portfolios at least twice per year if not more.
2. Funding Future Distributions
Let's face it: the current interest rate environment may not offer retirees the luxury of living off of portfolio income alone. Accordingly, selling a portion of your stock holdings to supplement interest and dividend income is common practice and can make perfect sense for funding retirement expenses.
Helpful Hint: The earlier you plan for upcoming expenses, the better. The last thing you want is to be forced to sell stocks to pay for your Florida trip when the market is down 40%.
3. Reducing Concentration Risk
I recently met with a prospect who purchased a handful of FAANG stocks several years ago and slowly watched as his initial $100,000 investment grew to $1.2 million. Kudos to him for getting in on the tech boom early and holding.
The problem, however is that the majority of his wealth is tied up just three companies within the same sector of the market. While this is arguably a good problem to have (the $1.2 million part that is), the success of this person's retirement is dependent upon the success of those companies, any of which could drop precipitously at any moment. This is known as concentration risk, which basically means having too many of your eggs in one basket.
One way to reduce concentration risk is to establish a strategy for selling out of your concentrated positions and diversifying into other areas of the market. Your strategy may depend on multiple factors including taxes, risk tolerance and funding of living expenses.
Helpful Hint: Have a detailed plan of attack and be disciplined with your execution. Understand the tax consequences of selling but don't let taxes drive every decision.
4. Tax Management
Another reason it makes sense to sell stocks is to capitalize on losses that can be deducted on your tax return while using the proceeds to purchase something similar in the marketplace (i.e. selling Apple and buying a tech ETF). This is known as tax-loss harvesting which I wrote about in more detail here.
Helpful Hint: Beware of the 30-day wash sale rule which prevents you from selling a security, taking the loss and purchasing the same or "substantially identical" security within 30 days.
5. Modification to Your Financial Plan
One of the few guarantees that come with any financial plan is change. Whether it's how you feel about risk a year from now or a spontaneous cruise you decide to treat the family to for Christmas, change is inevitable and will often require an adjustment to your portfolio in the form of selling stocks.
Some of the larger, more impactful changes to your financial plan that may warrant selling stocks include: a health-related event, increase in living expenses, a large asset purchase like a vacation home or vehicle, reducing market risk, the list goes on.
Helpful Hint: Like with funding future distributions, plan early. The sooner you talk with your financial planner about current or potential changes in your financial life, the sooner they can proactively make adjustments to your investment strategy.
The 3 Instances it Makes Sense to NOT SELL Stocks
1. Trying to Time the Market
This chart from Bank of America pretty much says it all.
If you sold stocks trying to time the market and missed the 10 best days each decade going back to 1930, your total return would have been 28%. Had you stayed invested the entire time, your return would have been 17,715%!
Obviously, avoiding the 10 worst days per decade yielded the highest return, though you'd have a better chance of winning the lottery and getting struck by lightning than you would selling at the right time.
Helpful Hint: Don't try and time the market!
2. Market Pundits Predicting Doom and Gloom
Harry Dent has made millions selling books warning investors of bubbles bursting in the stock market. Dent claims he can accurately predict future market trends which are, in his mind, always going down. Unfortunately, Mr. Dent's wealth is more of a result of book sales than following his own advice.
If someone could accurately predict the future of the market, would they need to publish an "end of days" book every two years? Looking back over the past 20 years, stocks crashed in the early 2000s with the internet bubble, in 2008 when the housing market plummeted and most recently in 2020 due to the global pandemic. Just like a broken clock tells the right time twice a day, charlatans like Harry Dent will eventually, and temporarily be right. But being right in this case means potentially missing out on the 10 best days in the market which, per the chart above, can be costly.
Helpful Hint: Avoid listening to "experts" who claim they have a proven formula for consistently predicting stock market crashes. It doesn't exist.
It's one thing to say you'd be unphased and eager to buy more if stocks fell 40%. It's quite another to experience a $400,000 loss firsthand.
The fact remains, investors are human and humans react emotionally when it comes to their money, no matter how many times CNBC regurgitates a "buy low sell high" quote from Warren Buffett.
It's never a good idea to let emotions cloud your judgement, especially when it comes to your investments. The last thing you want is to end up like one of the many retirees who sold all their stock positions at the market bottom in early 2020, only to see the S&P 500 end the year up 16%.
Helpful Hint: Be honest with yourself when determining your tolerance for risk. Having too much stock exposure when you're losing sleep over 3% moves in the market may lead to poor financial decisions down the line. When in doubt, talk to a financial advisor.
When someone asks me if now's a good time to sell their stocks, my response is always the same: "What are you trying to achieve?"
Selling stocks is not an investment strategy but rather a component of larger, more comprehensive plan. So if you feel tempted to pull the trigger, take a moment and think about what's driving you to want to sell and ask yourself if you're doing it for the right reasons.