3 Questions to Ask Yourself Before You Sell a Stock

There are a lot of valid reasons to consider selling a stock, and there are a lot of not-so-good reasons as well. We asked three of our analysts what investors should ask themselves before selling a stock. Here's what they had to say.

Source: 401kcalculator.org via Flickr.

Dan Caplinger: One question it's important to ask before you sell a stock is what the tax consequences will be. If you're investing in an IRA, 401(k), or other tax-deferred account, this question is easy because the answer is that there typically won't be any tax consequences at all.

For investors in taxable accounts, though, the tax impact of a sale can be considerable. For a long-term holding, years of profits can result in a huge capital gain when you sell, and you'll have to pay capital gains taxes of up to 20% on those profits. Meanwhile, if you've owned a stock for a shorter time, you need to look at whether you'll potentially owe short-term capital gains tax when you sell. If you've owned the stock for a year or less, then the higher ordinary tax rates apply to short-term capital gains.

Sometimes, the tax burden is one reason to hold onto a long-term holding when you'd otherwise sell. For investments you haven't owned as long, waiting until you pass the one-year holding mark can dramatically reduce your tax bill.

Finally, note that tax considerations should never be your only reason for holding on to a stock. If the fundamentals of the company you're investing in deteriorate, then it's far better to sell and pay tax on profits than it is to watch those profits disappear as the stock price falls. Nevertheless, you should at least know the tax consequences before you make a final selling decision.

Selena Maranjian: So you're going to sell a stock. Why? There's a good chance you're moved to sell it because it has been disappointing you. If so, you'd do well to ask yourself, "Is this company in serious or temporary trouble?" That's a critical question, because with a temporary problem, you might want to hang on. And with a serious, more lasting problem, selling may be your best choice.

Let's consider the fleeting problem first. Perhaps the company reported quarterly earnings with lower-than-expected results because of a fire at a factory or weakness in Europe or a drug rejection from the FDA. If so, and the stock has fallen, selling now will give you a loss or a smaller gain than you had before. Think about what's likely to happen with the company. The factory's fire damage will probably be repaired and production will ramp up again. Europe's economic woes may linger, but not forever. That one drug might never make it to market, but it might be approved for some other indication, or the company might have other promising drugs in its pipeline. Hanging on isn't always best, but give some thought to the situation and determine whether you think it's still a healthy company with solid growth prospects.

But maybe the company's problems seem more intractable. Maybe its best-selling drug is being eclipsed by a newly approved drug that's cheaper and more effective, and it has little else in its pipeline. Maybe the rubber hats it made that were all the rage are no longer the rage. Maybe serious accounting problems have just come to light, and it seems that management has not been forthright. If you no longer have confidence in the company and its prospects, then selling is the right thing to do.

Keith Speights: Many people know that Warren Buffett once stated that his "favorite holding period is forever." Even Buffett doesn't hold every stock forever, though. The truth is that sometimes we buy stocks that shouldn't be held indefinitely. Investors need to ask themselves from time to time, "Is there a better place to put my money?"

This doesn't mean you should jump from one stock to another, continually looking for the next big thing. But there are times when shifting your money to another investment opportunity makes sense. Back during the financial crisis, for example, Buffett sold portions of some stocks to make other investments that had the potential for better long-term returns.

Sometimes previously well-managed companies aren't run so well anymore. Sometimes companies' valuations get so high compared with the cash they're likely to generate that your money has better prospects elsewhere. In these cases, sell and find a better alternative. As Buffett once said when comparing investors to Cinderella at the ball: "Overstaying the festivities ... will eventually bring on pumpkins and mice."

The article 3 Questions to Ask Yourself Before You Sell a Stock originally appeared on Fool.com.

Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.