When investing in stocks, most people make the wise decision to diversify their investments between many different companies and industries. While this can be a good investment strategy, even savvy investors will see certain investments lose value over time. When this occurs, there are many factors that need to be considered to determine whether it would be better to sell off the underperforming asset or to hold it in an attempt to continue to diversify your portfolio.
Temporary or Permanent Loss
The first factor that needs to be considered is whether you believe that the loss is temporary or if it will be a permanent loss. Even good stocks can go through periods of ups and downs. If you have a stock that has continued to lose money, there is a chance that it is only temporary and that it is poised for an increase. However, if the company has continued to underperform, has lost market share or key management, and is simply struggling, it could be a sign of bad times ahead. If you believe that the loss is temporary, it would be wise to hold and continue to invest. However, if the loss is thought to be permanent, then you should sell.
Another factor to consider when you are looking to sell an underperforming investment is if you have another investment targeted that could act as a good replacement. If the company you are currently invested in is in a promising industry, but is struggling to make money, it could be a good idea to find a replacement investment in a company in the same industry that is doing well. This way, you will still be able to take advantage of the industry potential, but will not have to lose money by investing in a struggling company.
Diversity after Sale
The third factor that you need to consider when deciding if you should sell an underperforming asset or to hold it for diversification is if you will continue to be well-diversified after the sale. If you sell the stock and then are highly concentrated in one company or industry after the sale takes place, you may want to consider continuing to hold. If you do sell the stock, then it would be wise to re-allocate your investments to make a more balanced portfolio. In general, no more than twenty percent of your investments should be in any one stock.
While selling a losing investment may help you to stop seeing declines in your account value, another factor that needs to be considered before the sale is if you will be missing out on a dividend or distribution. In order to entice people to continue to invest in the stock, some companies that lose money may offer distributions to stockholders. If there is a distribution coming up, it could be a good idea to continue to hold the stock, at least until the dividend is paid out.
In conclusion, when holding a diversified portfolio of stocks, all investors will eventually own an under performing investment. When deciding whether or not to sell and take a loss, or continue to hold to remain diversified, there are several factors that need to be considered.