Breaking Up With a Bad Investment
You can get emotionally attached to an investment, just as you can with a person. And, as with a personal relationship, it can be very hard to bite the bullet with an investment and call it quits. Sometimes your head tells you one thing, but your heart another.
However, as an investor, you need to listen to your head, and remain coldly rational about your holdings. When a stock, bond or mutual fund has soured and it's time to sell, don't agonize over it. Dump it! Here's how to tell when the time is ripe for a break-up.
When to Sell a Stock
A rule of thumb: Any equity that you now hold but no longer consider to be a "buy" candidate should be a strong contender for sale. If the stock has served you well in the past, you may be reluctant to sell it. But put on your analyst's cap and ask yourself this question: If I had to rate this stock, would I give it a buy, sell or hold? If the answer is "sell," then follow your own advice, and do so.
To make the decision easier, remember that you don't have to dump your entire holding. If you think the stock might hit the floor but still has potential, then, at the very least, pull back your position. You could sell half and then put off making a decision about the other half. Nevertheless, don't just hang on to a stock that you've soured on simply out of inertia or sentimentality.
For starters, don't be impulsive and act too fast. What happens all-too-often is an investor picks a stock mutual fund because of its stellar past performance, but quickly becomes disillusioned when the first couple of quarters are disappointing. He or she dumps the fund out of frustration -- only to see the fund eventually live up to its historic performance.
That's why, when a fund that seemed good on paper starts to go south, the first thing you need to figure out is why. Compare the fund's average performance to similar funds and examine the overall context. Maybe the problem isn't with the fund managers but with that particular sector. Sometimes patience is the best counsel and all you really need to do is ride out the turbulence. The time to sell is when your fund is doing poorly compared to its peers.
When to Sell a Bond
Don't ever buy a bond unless your original intention is to hang on to it until it matures. That said, situations might arise in which you need to sell bonds to recalibrate your portfolio's asset allocations, or if you need to raise cash quickly. The most persuasive reason to dump a bond is when the issuer, whether a corporation or a municipality, is unraveling at an accelerating pace.
Hopefully, your bonds are highly rated or they're U.S. Treasuries. However, if your bond has a lower rating and you find yourself in that unenviable position of watching its issuer deteriorate, secure the services of a savvy broker to make sure that you get the best possible price. Furthermore, remain informed at all times about the credit status of your bonds. A common mistake is to put bonds on autopilot, but that's a bad move because circumstances surrounding bonds can change rapidly.
Through it all, always remember that diversification is your best defense against the vicissitudes of the economy and the markets. Having a well-balanced portfolio will compel you from time to time to sell certain investments in favor of buying others.
Never get too emotionally attached to any one investment. Instead, invest your emotions in your friends and family, where the dividends are higher. [As they say, "Knowledge is power." Learn how to recognize (and therefore avoid) the 5 Signs Your Emotions Are Taking Control of Your Investing.]