You need to know when to fold ‘em
Many of us spend a lot of time deciding whether to buy a stock, but we give little thought to when to sell. That’s risky, leaving us holding some stinkers too long.
Don’t sell just because a stock or the market is falling, you’ve heard some rumors about the company, or someone tells you to sell. Do consider selling:
• If you can’t remember why you bought in the first place.
• If you don’t know what the company does and how it makes money.
• If the reason you bought a stock is no longer valid. If you bought shares of Microsoft because of its high profit margins and then it announces it’s buying a large supermarket chain, stop and re-evaluate the situation. Supermarkets are a different business, with lower margins.
• If the stock has become significantly overvalued relative to your target price, if you have one. If you bought shares of Apple at $40 per share and it’s now trading around $70, well above your target price of $55, you might sell. Consider the tax consequences, though. If you expect the stock to hit $90 in a few years, you might do well to just hang on.
• If you find a much more attractive place to invest your money. If your calculations suggest that a holding is now fairly valued and another stock appears to be undervalued by 50 percent, you may stand to gain more in the other stock. Again, consider tax effects.
• If a stock is your only holding. Portfolios should be diversified. Our rule of thumb is to aim to hold eight to 15 stocks. If one grows to represent more than, say, 20 percent to 30 percent of your portfolio, consider rebalancing it.
• If you’ll need that money within a few years. Any greenbacks you’ll need in three to five (or 10) years should be in a less volatile place than stocks, such as a money market fund or CD.
• If you’re hanging on only for emotional reasons.
Ask the Fool
Q: What is a company’s “business model”? — B.B., Fort Wayne, Ind.
No, it’s not Bill Gates in a bikini. A business model is how a company makes its money. To best understand the concept, think of online marketplaces eBay and Amazon.com. Ebay’s business model brings tears to many investors’ eyes — connecting individual buyers and sellers online, and profiting by taking a percentage of each sale, all without carrying any inventory. Amazon.com’s main model is more capital-intensive, requiring warehouses to store many products so that they can be quickly shipped out to customers. Even more capital-intensive is Barnes & Noble, featuring hundreds of brick-and-mortar stores.
When evaluating a company, learn exactly how it makes its money. Then assess how attractive and profitable that business model is. Will it permit the firm to grow quickly and to fend off competition? Is it expensive to maintain?
Q: I plan to buy my first home in three years. How should I invest the money I’m saving in order to get maximum returns on it? — S.K., Atlantic City, N.J.
A: Unfortunately, the place that’s usually best for long-term investment appreciation, the stock market, should be off-limits to your moolah. In the short run, the stock market can go up — or down. In the long run, it has averaged about 10 percent or 11 percent per year, but that is an average, not a guarantee.
www.fool.com/savings and www.bankrate.com.
My smartest investment
When I retired in 1991 from what is now U.S. Bancorp, I had invested about $12,500 through my 401(k) plan in company stock. Instead of cashing it out, I rolled it over into an IRA account. I haven’t withdrawn any of the money. With the reinvested dividends, the account is now worth more than $200,000. It’s the best investment decision I have ever made. — A.A., Florence, Ky.
The Fool Responds: You did very well. We hope you’ve had other investments along the way, though. Concentrating too much of your nest egg in any one company’s stock is risky, even if it’s an employer or former employer that you know very well. Just think of Enron. You were also smart to roll the money into an IRA (for the tax benefits) and to let it grow over many years.