Q: How do I know when to sell a particular investment? I would like to reduce my risk in case of a major market downturn.
A: This is a very good question that many investors, individual and professional, struggle with. I believe that the first step is to have a well-diversified portfolio.
When I speak of diversification, I mean having your investments in a wide variety of asset classes that have low correlations to each other. Diversification and asset allocation do not guarantee against market loss or ensure market gains. They are techniques to help manage investment risk. Unfortunately, during the economic downturn of the past couple of years we saw high correlations with many asset classes all moving down together.
Once you have a well-diversified portfolio, it can be prudent to have a “sell” strategy for your different asset classes.
There are many strategies and theories on how to implement sell decisions. You may want to take a macro (big picture) view when determining buy and sell decisions.
This involves analyzing the economic environment, the business environment, the outlook for inflation and interest rates and other factors that might affect your holdings. A micro view involves drilling down into your individual holdings and determining if they still fit into your portfolio. This could involve more analysis of the specific companies, industries, mutual funds or ETFs, bond issuers, etc., that you hold.
While this fundamental analysis is important in making investment decisions, it might be said that fundamental analysis can help more with what to own rather than when to buy or sell.
A simple strategy that you might implement is to place a “stop” on your holdings. If your holding drops to this price, then a market order is placed to sell the holding. This might protect you in a falling market. However, in a volatile market a short-term swing in price might bounce you out of a holding only to see the price rebound back. You must consider the trading commissions and tax consequences that might result from such a strategy.
Other strategies attempt to identify technical trends that might indicate good entrance and exit points for investments. A simple easy-to-follow system involves the use of moving averages. Many of the popular finance sites offer free charting programs that will chart the price of a particular holding versus a certain moving average period (200 day, etc).
There are many other technical strategies that you might consider. A lot of information on technical strategies and trend analysis can be found on the Internet and in books available through popular bookstores.
Finally, there are strategies involving options contracts that you might want to explore. The Chicago Board Options Exchange site, www.cboe.com, has some good educational resources for protective strategies.
I would encourage you to research the information that I have discussed. If you work with a financial professional, then you should discuss which techniques might be appropriate for your situation.
The important thing is to have a plan and discipline yourself (and your advisers) to stick with it. In the long run, investments will most likely follow the underlying fundamentals. However, investor sentiment and the supply and demand for investments can drive shorter-term pricing levels.
Understanding how to identify these trends can help you with your entrance and exit decisions.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Greg Epps is a registered representative and Certified Financial Planner with Epps Financial Partners. Securities are offered through NEXT Financial Group Inc., member FINRA/SIPC. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at firstname.lastname@example.org.