Loser Stocks: Should I Stay or Should I Sell Now?

When I was in high school, I got introduced to punk when punk rock bands crossed "The Pond" and invaded the airwaves. One of the most memorable for me was the Clash with their enduring song of angst, “Should I Stay or Should I Go Now?" Fast-forward to today and their song has as much to do with investing as it does with pivotal moments in any relationship. Often I’m asked by investors if they should hold on to or sell an investment or, “Should I stay or should I sell now?” With The Clash providing the soundtrack, let’s look at this question.

Should I Stay or Should I Sell Now?

Question: Should I sell a stock that’s down 70% for income tax purposes? I bought a stock in 2013 and it’s been nothing but a total loser. It’s down 70% and I see no solution other than to sell for income tax purposes and deduct my losses. I bought it for $10,000 and it’s now worth $3,500. Is selling a good idea?

Answer: This is a great lesson in diversification. You may buy into the ground floor of the next Facebook or you may find you lose everything. First, you should only put at risk that which you can afford to lose. Sometimes the best investment is not a stock but yourself. Funding an emergency reserve or paying off high-cost (non-tax-deductible) debt will oftentimes yield you the best return.

But assuming you’ve got the other bases covered, a risky investment (and all stocks have risk) is a good way to build wealth. I recommend to clients that they first fund their core with a broad, globally-diversified mutual fund or exchange-traded fund (ETF). A low-cost, passive index fund is a good place to start (Vanguard Balanced Index Fund offers a mix of stocks and bonds all in one fund). You’ll have diversification and be able to capture any upside. No, you won’t hit a grand slam and become a multi-millionaire overnight. (For related reading, see: Introduction to Exchange-Traded Funds.)

Whenever you buy any investment you need to have an idea of what you want from it. A compelling story is a good start and provides the sizzle. But you’ll need to understand the risks in the business: products, government regulation and competitors. Warren Buffet refers to this as the "moat" and business school grads might call it the firm’s unique selling proposition. After understanding this, you should have a plan in place of how long to hold it. The hardest part of investing isn’t the number-crunching analysis, it’s an investor’s emotions. Without a plan, you can easily doubt yourself and be frozen by indecision or fear

Begin With the End in Mind

So, before you buy any investment, you should have an exit plan. Much like you’d check for fire exits when you enter a theater just in case something happened, you need to have an exit plan for your investments.

Perhaps you set a rule in place that says you’ll hold an investment for three years. At the end of your target holding period, you may reassess and set new rules to hold or sell. Based on your research you figure it will go up 30%. On the other hand, you’ve seen the statistics that show it has a 20% standard deviation. So, going into this, you should understand that the stock very well might drop 20% in any period. While that wouldn’t be great, it’s not unexpected so you shouldn’t panic. 

On the other hand, you could have as part of your exit plan a rule that says when an investment drops 30% from your purchase price within your target holding period, you’ll sell. Period. No questions. No emotion. 

Without knowing the particulars of an investor’s situation, it’s hard to provide specific advice. But here’s a guideline to consider:

  1. Check to see what the prospects are for the company’s products. Is there still a compelling value proposition for the company? Any special proprietary technology or products? Because of these, it’s possible that the company may be a candidate for merger. Merger candidates typically see their stock prices increase when an offer is made. On the other hand, if the firm’s financials are weak with lots of debt and a risk of bankruptcy, then an exit is even more compelling. (For related reading, see: How Mergers and Acquisitions Can Affect a Company.)
  2. After answering question one, then sell, getting your best price.
  3. Fund your emergency reserves.
  4. Use some of the proceeds to pay off any higher-cost personal debt.
  5. Use the balance to buy into a broadly diversified passive index fund.

If you find yourself frozen with indecision when it comes to your money, reach out to a certified financial planner. 

(For more from this author, see: Why Paying off Debt Is Priority Number One for Advisors.)