September 13, 2008 in Business

Sometimes it’s OK to sell those lemons


We admire people who look into the eye of adversity, dig in their heels and persevere, no matter what the odds. But in investing, it’s best to stare defeat in the face, lace up your sneakers and run screaming into the woods.

Much of financial literature lauds the virtue of long-term buy-and-hold investing, and it’s true: If you invest in stocks over very long periods, you typically earn more than you would from less risky investments, such as bank CDs and bonds. If you’re willing to hang on through the tough times, your investment rewards can increase with the risks you take. That said, there are some perfectly good reasons to sell, too.

For example, while it’s fine to hold a diversified portfolio of stocks through booms and busts, specialized stock funds and individual stocks carry far more risk than, say, a fund that tracks the Standard and Poor’s 500-stock index.

The axiom that “rewards increase with risk” has limits, just like, “The faster you drive, the sooner you get there.” If all you had to do to achieve wealth was to take on more risk, then all financial wisdom would boil down to buying lottery tickets.

If you own stocks or funds with above-average risk, selling is a better option than holding through catastrophic losses, which can lead to the permanent destruction of wealth, not the creation of more of it.

And a long-term investment outlook doesn’t necessarily mean keeping every holding until the bitter end. Some companies become obsolete over time. Of the 500 companies in the index in 1957, for example, only 57 stocks remained by 2007.

In short, there’s nothing inherently wrong with selling. And if you hold your stocks or funds in a taxable account, selling has a distinct advantage: You can reap excellent tax benefits from selling your losers and using them to offset any amount of long-term capital gains.

If you’re convinced that your loser will someday become a winner, you can buy shares in the company again, though you must wait 30 days. If you repurchase your stock sooner than that, you’ll generate what’s called a wash sale, and the IRS will disallow your losses.

No one likes losses, and tax relief does only a little to ease your pain. But if you’re in a losing investment and you see no hope in sight, then gird your loins, stare disaster right in the eyes and run like crazy.

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