What type of shares do you sell - the good ones or bad ones?

Question

This may sound like a n00b question, but I've never seen any guidance on exactly which shares to sell when wanting to convert some of my portfolio into cash to use for spending.

There are many online articles about re-balancing portfolios which sounds good in theory, but they simply advise you to sell a percentage of shares to get the overall portfolio share close to your target. All good, but which shares to sell?

To keep it really simple, my question is when selling shares in a portfolio (let's say for almost any reason, but if it matters my specific reason is because I'd like to use the proceeds for life expenses), do you generally:

1. Sell shares that have outperformed the market. The rationale here may be that you're "taking profits" from shares that have performed well, and that this is these shares' purpose - you're not meant to hold shares forever, and ones that have grown well over time are there for the purpose of "harvesting"
2. Sell shares that have underperformed the market. The rationale here may be that these shares may be duds anyway, so you're better off cutting your losses and removing poor performers from your portfolio. May as well convert them to cash to spend since they haven't performed well from an investment point of view

I know that past performance is no indicator of future returns - I'm not a finance or investing novice. But I've never seen this specific question answered and I feel certain that investment professionals generally choose between one or the other, all else being equal.

Even though I'm only looking for a general answer that may be a "rule of thumb" for practitioners, in case it makes a difference to the answer my situation is as follows:

• Significant capital in the market (let's call it an even million)
• I don't need the cash - I'd just like it to fund lifestyle choices like better travel etc.
• Purpose of investment is long term growth, but I also wish to draw down on the portfolio every year (sort of using the 4% rule, but not exactly) to fund my lifestyle and so that I don't have to work, or can work a lot less
• About 15 years away from retirement age
• Most of my funds are in shares, with a small percentage (let's say less than 10%) in debt-like instruments and cash. Not enough to care about for the purposes of this question
• Portfolio is directly invested in (i.e. not an index fund or similar)
• Country is Australia, but I also direct invest into global shares. However I'd suspect that this rationale should apply regardless of country

Note that this question and answers come close:

I need cash. What funds or stocks should I sell?

but I'm not happy with the "sell bits of everything" answer as this seems like a massive PITA to me and not really in keeping with the spirit of the question. It doesn't seem the best approach to me to sell a few shares of every stock I own, rather than sell all of the stock of one company.

Thank you.

Answer 1

Buying or selling should be based on future performance.

That thing you are pursuing does not exist

You are trying to make a "pick a stock to sell" decision based on PAST performance. That is a useless metric. It provides no hint as to what those stocks are going to do tomorrow. This fails in both directions.

• The logic of "past loser is going to keep losing" is faulty; it may be undervalued and go up! The FDA may approve their drug etc.
• The logic of "top performer will keep climbing" is equally faulty; it may be overvalued! The CEO who holds the place together may get hit by a bus.

The premise of your question is that you can extract wisdom about which securities to sell based on their past stock movements. You just can't.

You need to either do the proper research on each company and understand its prospects relative to their industry and the economy at large... OR... you need to realize how difficult this is to do without a very substantial research staff... and pick up John Bogle's book Common Sense on Mutual Funds about how to diffuse risk and play entire markets i.e. so you are betting on a national economy instead of particular companies. TLDR: Index Funds, and the biggest profit there is in minimizing fund expenses/fees.

Answer 2

The first shares you should sell are the ones that destroy your diversification.

So, for example if you had purchased Tesla at $270 before splits ($18 after splits) to make 5% of your portfolio, and you had just found that Tesla is at $125 ($1875 before splits), now Tesla makes 27% of your portfolio assuming other stocks hadn't changed in value.

So, in that case, you should sell. Not because it's a bad investment now, but because you should diversify and your current holding in Tesla is wrecking your diversification.

One strategy to sell if you don't think Tesla is overvalued right now is to restore the diversification: sell as many shares as needed to make Tesla again 5% of your portfolio.

Only after your portfolio is diversified again, should you think about selling other stocks. Then you should consider selling as reverse of buying: if you wouldn't buy the stock anymore at the current price, then sell and buy something you really want to buy right now. Remember also that selling has tax consequences: selling at loss can offset tax liabilities, selling at profit can create new tax liabilities.

Answer 3

If you are dealing with individual stocks, you need to have a specific belief and level of confidence in whether each stock is going to go up or down in the future. You want to buy low and sell high, so you want to sell the securities which you have least confidence in (preferably when they will deliver a profit) and put money into the securities you most believe will go up from where they are now (preferably when they are relatively cheap). Whether either is outperforming or underperforming vs. the rest of the market is not the right question; the question is whether you believe they will over perform or underperform.

That's far too much work and stress for me, and I don't believe I can predict better than the pros do, so I don't deal with individual stocks. Each of my mutual funds (yes, low-fee index funds) addresses a different category of investments -- large cap, small cap, bonds, real estate and other "income" investments, international. I know how I want my money spread among these categories. Every month or so I take a look at how far my actual mix has drifted from that preferred mix and consider rebalancing back to those relative percentages. (If it's less than a percent or two off, I may not bother... and realistically I could probably get away with rebalancing once a year in a normal market.) Painless.

Answer 4

This is a sufficiently naive question that you, like the majority of investors, probably aren't doing yourself any favors by investing in individual stocks–especially if as it sounds like, your entire equity portfolio is individual stocks. That's an extremely unusual appetite for risk, and you're not all that far off from retirement! (For comparison, Vanguard's target 2035 and 2040 funds are up to a 20-27% bond allocation already and have all their equity allocated across the entire market.)

Anyway, it should be obvious that this decision depends critically on the specific stock. If you own Generic Value Stock and it's gone well above its historic range, this could be a great time to sell while waiting for it to come back to earth, assuming that there's not some good reason for its typical range to have shifted! But much of the time, selling stocks that are up is giving up future gains. If you own Exciting Growth Stock and it, like most growth stocks, is way down this year, but your thesis that it's going to go to the moon over the next decade, then you ought to be buying more, not selling. But if you decide your thesis is broken, then you should sell.

Notice that none of these decisions have anything to do with your desire for cash. If you're living off your investments and selling regularly, then you will necessarily not be making sales at the optimal time for your returns. But you should still be able to rank your stocks by what you expect them to be doing in the future and sell the one you're least optimistic about. Another option is to invest in dividend- and interest-paying instruments to an allocation allowing you to sell mainly when you want to sell for maximizing returns, not for getting access to cash. But just to repeat, by far the typical case is that all this hard work ends up with worse returns than just buying index funds.

Answer 5

Of course, you should sell off the stocks that are not performing. If these stocks continue to fall they will be a hindrance to your total portfolio. You need to set a limit to how far you will allow your shares to drop before buying them, then stick to your plan.

For stocks that are outperforming and continue to outperform, you should keep these until they are not outperforming anymore. But how do you know when they stop outperforming? You don't. So instead let the market tell you when they stop outperforming. Set a stop loss at 20% or 25% below the recent highs. If the stock drops by that amount you can let the market take care of it. Again you need to set these stop losses before you even enter the trade, and once again stick to your plan.