With the stock market continuing its gains this year while macroeconomic challenges loom, many investors wonder how long it could be before a correction.
A natural part of this thought process is considering the possibility of selling stocks while prices remain high. Is it time to sell or hold on?
Is Market Timing Smart?
The first consideration is timing the market. Hypothetically, selling while share prices are high just before a dip is a good way to lock in returns and avoid losses. In reality, however, it almost rarely works with any level of consistency due to the complexity and volatility of markets.
Poor market timing can cause investors to miss out on potential gains or, under worse conditions, lock in losses by selling holdings in a bear market.
In some market conditions, timing the market can also become a justification for emotionally driven investment decisions. Buying a stock because it’s rising or selling it at the first sign of trouble are easy ways to lose money in the market over time.
Instead, investors usually do better by focusing on the time-tested approach of buying high-quality companies that trade below fair values based on their ability to produce future cash flows. Under this model, selloffs actually tend to present better opportunities to buy than to sell.
Ironically, backward-looking datasets suggest that timing the market wouldn’t be all that beneficial, even if it was possible. Hypothetical investors who achieve perfect market timing come out only about 11% ahead of those who invest once a month or once a year over a 20-year time frame.
While an 11% gain isn’t insignificant, the risks of attempted market timing are far greater than the comparatively minor rewards.
Benefits of Holding for the Long Term
Just as selling stocks when market conditions become choppy can rob investors of potential gains, the buy-and-hold approach tends to amplify gains over time.
In addition to preventing investors from selling into down markets, holding allows investors to avoid tax consequences and trading fees, both of which can eat into total returns.
Combined with the long-term historical trend of rising stock prices over time, these factors make holding a good choice under most circumstances.
It’s also important to consider the convenience and psychological benefits of a buy-and-hold strategy. Unlike those who are trying to time the market, buy-and-hold investors don’t have to check prices daily and may experience less investment-related stress.
This, in turn, makes it easier to avoid a classic emotional cycle that can lead to poor performance or even the choice to exit the market altogether.
Lessons From Warren Buffett and Peter Lynch
While timing the market and fears of volatility can cost investors money, there are obviously times when it makes good sense to sell a stock.
For proven selling criteria, two of the best possible sources are Berkshire Hathaway founder Warren Buffett and Fidelity Magellan manager Peter Lynch. Both of these investors have successfully beaten the market over long periods of time, making their strategies quite important for investors to study.
Buffett has famously stuck to two main criteria for selling stocks. The first is that he believes the money could be invested more productively elsewhere. This factor was more relevant to Buffett in his early days before Berkshire Hathaway had one of the corporate world’s largest cash stockpiles.
More importantly, Buffett will sell a stock when the company’s business fundamentals or competitive position change dramatically for the worse. Through this approach, Buffett has been able to contain losses by not sticking with fading companies.
Peter Lynch stuck close to these guidelines but also added to them for a more comprehensive set of investing principles.
Lynch believed in the idea of a stock’s “story” or a general trajectory investors believed the company would follow. When the stock’s story reached its logical end, Lynch generally argued for selling and moving on to another stock with a compelling story.
For example, an investor buying a cyclical stock at a low point might want to sell when it reaches a positive part of its cycle, thus locking in a return and freeing up capital for other investments.
A final lesson investors can learn about selling is one that Buffett and Lynch famously bonded over. Lynch summed this lesson up in a phrase that was later borrowed for one of Berkshire Hathaway’s annual reports: “Selling your winners and holding your losers is like cutting the flowers and watering the weeds.”
For long-term compounding companies, it’s often best to hold and allow the stocks to produce further returns. Holding onto losing stocks without a compelling reason to believe they will improve, on the other hand, creates opportunity cost by locking money away in unproductive investments.
Jack Bogle’s Advice On When To Sell
Advice from Buffett and Lynch is very useful for investors dealing with single stocks. For those who passively invest in index funds, however, it’s more useful to turn to Vanguard founder Jack Bogle.
Bogle’s strategy boiled down to a phrase he personally popularized: “Buy everything and hold it forever.” In other words, buy a broad index fund and maintain your holdings throughout any and all market conditions. This strategy is safe, simple and produces excellent results, provided investors are willing to stick with it for decades at a time.
Though Bogle did become famous for this approach, he also acknowledged that it could sometimes make sense to reallocate a portfolio to include a higher or lower percentage of bonds.
He was also an early proponent of increasing bond holdings with age. So, while buy-and-hold is an essential strategy for passive investors, it may occasionally be necessary to sell stocks in order to put more money into safer bond holdings.
Should I Keep My Stocks or Sell?
According to Warren Buffett, the time to sell stocks is when the fundamentals have changed or a better opportunity to buy exists.
All other things being equal, it’s generally best to hold stocks until a compelling reason to sell comes along. Whether that reason is a better investment opportunity or a fundamental change in a given company’s business, it’s important to weigh selling decisions carefully and avoid making choices based on emotion or transient market conditions.
Though the market could be in for a volatile time in 2024, past data suggest that trying to time the market by selling stocks broadly is a losing strategy over the long-term.
Still as Buffett has remarked, if one or more stocks has become a fundamentally unattractive investment, it may be a good idea to sell it and look for better opportunities to deploy your capital. Otherwise, history suggests that holding remains the strategy with the highest likelihood of success.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.