There are many reasons not to sell a stock , no matter how tempted. My last column covered some of these reasons.

However, it’s also important to know when to call it quits, reduce risk or take some profit. So here are some reasons you should sell.

Portfolio management

The absolutely easiest reason to sell is for risk management purposes. When you have a stock that has done really, really well, it may have become a large part of your portfolio . If you targeted a four per cent weighting in a stock and it is now eight per cent, simply re-balancing is a totally legitimate reason to sell. Such a move reduces risk, rebalances a portfolio towards goals, and, let’s face it, makes one feel good about picking a winner. You are not exiting a full position, just re-positioning. This reason to sell becomes even easier if you have a giant winner that has become, say, 15 per cent of your portfolio. Now your entire portfolio is essentially taking a bet on a single position. We like letting winners run, but only to a reasonable bet. Once a whole portfolio’s performance is dependent on stock, it is generally time to let some of it go.

Tax losses

There are no guarantees in the stock market except this: If you sell a stock and can claim a capital loss (in a non-registered account), you will pay less in tax than you otherwise would have. A loss can be carried back three years, used in the current tax year or carried forward indefinitely. There is a guaranteed tax saving in taking a loss, whether now, back-dated (one needs to refile taxes) or in the future. An investor in the highest tax bracket can save up to about 25 per cent in current, future or past capital gains taxes by taking a loss. Sure, taking a loss on a stock and admitting defeat can be painful. But who doesn’t like paying less tax? Tax-savings can take a bit of the sting out of losing money and is one of the best reasons to sell. Such tax discipline is also quite helpful in ensuring you get the loser stocks out of your portfolio. If you change your mind, it is no big deal. In Canada, investors can re-buy the same stock and still claim the tax loss, provided they wait 30 days before the repurchase.

The cockroach theory

Does it seem that with one of your investments there is always something bad going on? Does the company continually miss earnings estimates? Is there a revolving door at the executive suite? Is there always some lawsuit, or weather event? It is funny how some companies always blame the weather for bad results, as if they are the only ones affected. The cockroach theory for stocks implies that when you start seeing one or two problems, there are always more to come, just hidden beneath the surface. This theory goes hand in hand with frustration (see below). When a company has a continuous stream of problems, its valuation multiple has a hard time expanding and its stock typically struggles. After a few cockroaches, or problems, show up, investors actually start anticipating even more, and put any new buys on hold. Now, many companies can fix one or two problems. But when there are four, five, seven or ten issues a year, companies end up simply putting out the fires rather than prospering. This sell theory can at times be hard to execute, but if you start swearing to yourself every time your company issues a bad press release, it is often a good sign that maybe this is a sell candidate.

Frustration

This follows the cockroach theory. Now, I am not talking about bailing out of a long-term position simply on one missed quarterly report. I am referencing continued frustration from a stock that never seems to rise, falls even when the market is up, a company that uses its stock like an ATM (continually issuing shares), a company where there is always (it seems) some insider selling. To put things another way, if you are always frustrated by a stock holding, then you must realize that other investors are likely feeling something similar. In such cases, it is often best to sell. With a declining, annoying stock, it often takes a catalyst to turn things around, and a catalyst can be a long time coming. A frustrating stock uses up a lot of mental energy for an investor, and can be time consuming, trying to figure out what is wrong. This energy is probably better spent trying to find a new, better, investment.

Sector shifts

It has been proven that sector selection is just as important — if not more important, according to a Dow Jones study — than specific stock selection. In other words, you might own the greatest company in the world, but if it is in the wrong sector at the wrong time the stock may still not go up. Gold, metal and oil investors know this all too well. When oil falls, for example, it really doesn’t matter what stock you own: They may all struggle. Thus, selling to rebalance sector allocations may be just as important as rebalancing a big winner, as noted above. Trimming a sector does not mean you own bad companies, just that you might own them at the wrong time. This sell theory is difficult, as it does constitute a form of market timing. Sectors can turn (both ways) quickly. One way of looking at it is to look at market weightings. The TSX , for example, right now is about 17 per cent energy stocks. If your portfolio is at 26 per cent energy, you are now taking a bet on the sector. You may be right or you may be wrong, but either way your portfolio is now more closely tied to a single sector. This can be a good reason to make adjustments.

  • Tempted to sell a stock? Here’s why you should think again
  • How SpaceX’s IPO frenzy compares with previous FOMO investments and how they turned out

Peter Hodson, CFA, is founder of 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)

If you like this story, sign up for the FP Investor Newsletter.