Note: This is Part 2 of my 2-part Guide To Selling Stocks series. To see Part 1, click here.
Selling stocks is easy. At least in theory it is. The complicated part comes when we add taxes and emotions to the selling process.
I mentioned in part one of this guide that deciding whether to sell a stock is simply the inverse of when to buy.
We buy a stock when we believe it will improve our portfolio, by making it more undervalued or improving its balance.
We sell for the very same reason.
The difference is that making the decision to sell is a more difficult decision than buying because there is a larger emotional history attached to something we have owned for a while than to something we just bought.
Then, on top of that, we have the taxes to contend with.
The Impact Of Taxes On Selling Stocks
I am not a tax advisor, but it is important for us all to understand what impact taxes have on selling.
To understand this, we will have to compare what we currently have with the funds with what we will be able to reinvest in another company after we have paid all of the applicable taxes and costs.
Here’s an example to better illustrate my point…
Let’s say we are in the 46.5% tax bracket (the highest tax bracket in Australia). We have held on to a stock for over one year, making us qualified for the 50% personal capital gains tax discount. Our stock has doubled, making us responsible for paying 11.625% of our holding in capital gains taxes if we sell.
[half of current holding as taxable income] x [personal capital gains tax discount] x [marginal tax rate]
50% x 50% x 46.5%
11.625% of current holding
To make it all worth selling, moving to a different opportunity must make us even more in returns than the amount of tax we’d have to pay if we sold what were currently holding.
Of course, sooner or later we will wind up selling our holding and when we do, we’ll need to pay the tax.
If a new opportunity presents itself and it truly has a higher earning potential, then we need to consider whether it may be sensible to bite the bullet, pay the tax now and enter into a better opportunity that will make us more money.
Selling Less Often = Pay Taxes Less Frequently
Generally, the less often we pay a tax, the better.
That gives us more time to allow our money to work for us over time (assuming we hold on to our stock for over a year and we receive our 50% capital gains tax discount. If we are holding on to a stock in our name and are profiting, it generally does not make sense to switch before a year has passed, unless of course you have a profitable investment/trading system like our Blueprint.)
Alternatively, there may be times where it is more sensible to offset gains in our portfolio by crystallising a loss. This all depends upon each of our unique situations, so it is always best to consult a tax advisor on these matters.
No matter what, we must always keep in mind what capital we currently hold and have working for us and what we will have working for us after making any sales and moving on to a new opportunity.
If we find that it is significantly less, we will need to be pretty certain that the returns we receive from a new investment will exceed any costs we pay for selling our old one.
Beware Of Your Emotions When Buying And Selling
Although there are less financial concerns when we’re dealing with the emotions involved in buying and selling, it doesn’t make things any less difficult.
- When we have a stock that has had a stellar performance, it takes a lot of self-control to not get just a bit greedy or afraid of losing everything we earned.
- If we have a stock that is just plodding along, we can become bored.
- If we have one that turns out to be a catastrophe, it just might make us thirsty for revenge.
When we get caught up in our emotions, it is extremely difficult for us to accurately assess whether to sell or buy a stock. Of course, emotions are natural for us to experience and shutting them off is no easy task.
‘Stop Losses’ Don’t Stop Your Losses (Completely)
Speaking of emotions, when our stocks are falling and our losses are rising, it is easy to feel like a failure. One way we can get out is to do a ‘stop loss’, meaning if it falls by a specific amount, we sell.
Unfortunately, the only thing this accomplishes is to let us know that our stock has fallen to a specific level. It doesn’t stop our losses completely.
Another problem with this approach is that it makes the assumption that a mistake was made because the price of the stock fell. However, a fundamental of value investing is that the market itself tends to get the price wrong.
Let’s get back to the analogy of Mr Market I referenced previously. If we purchased a stock a day ago because Mr Market was clearly very depressed about its future, it would not be reasonable to expect that he will suddenly become rational today just because we own the stock.
There is no doubt that when things don’t work out as planned, we can experience many different emotions. Some of us may become angry and some may slip into denial. However, that doesn’t help the situation. What will help is to do our best to put those feelings aside, take action and sell.
We will all make mistakes. We will invest in the wrong stock and we will sell at the wrong time. What is important is to not be too hard on ourselves. Rather than trying to never make a mistake, a good goal is to get things right more frequently than we get it wrong.
The key is to maintain our objectivity and we can’t do that if we’re constantly dwelling on our mistakes of the past.