As published in the Financial Post on 26 April 2024

Question: Some of my security investments have increased in value in both my registered and non-registered accounts. I’m having a hard time knowing when to sell. Can you recommend a checklist of criteria to help me in making a sell or hold decision? – Myles

Answer: For an investor, making a sell decision is often one of the hardest things to do. There can be personal reasons for taking a capital loss, or in your fortunate case, locking in a gain. These can include tax considerations, estate planning, or simply a financial need to repay a loan or make a large purchase.  

A considerable amount of investment advice focuses on when to buy stocks, yet there is a noticeable absence of guidance on the equally important aspect of when to sell. This oversight is quite curious, considering that every transaction involves both a buyer and a seller, and the timing of a sale is a crucial factor in determining an investor’s returns. Ultimately, an investor’s return is the sum of the dividends received and the difference between the buying and selling prices over the duration of the investment. A lack of effective selling strategies can undermine the efforts of even the most astute investors who are great at finding undervalued stocks. 

Successful selling requires discipline and the deployment of the same tools and processes used in buying the asset in the first place. Human psychology plays an important role in making a sell decision. Unfortunately, emotional decision making is a common driver of “buy high, sell low” behaviour.  If you don’t have a solid thesis or full rational understanding why you bought the security in the first place, you probably will not know what changed that should make you to consider selling. Investing involves more than following a checklist or analyzing quantitative data; it is a blend of art and science. No investor, no matter how astute, will make the perfect buy or sell decision 100 per cent of the time. The goal is to be mostly right, most of the time. To accomplish this, the investor must be aware of three situations when it may be time to sell: Overvaluation, a better opportunity, or misjudgement.  

A security is overvalued when the market judges the business to be more valuable than the underlying facts indicate. Overvalued securities can stay overvalued for some time but eventually markets correct. There are some signs to watch out for. Overvalued securities usually have a lot of good news and lofty expectations already baked into their prices and high hurdles to beat. Should these businesses disappoint investors, their prices could drop rapidly leaving an investor with a loss.  

Sometimes a security remains a good investment, but the market is offering an even more attractive alternative opportunity. Stock prices change all the time. It makes sense to upgrade your portfolio when possible. In this case it may be prudent to sell some, or all, of a current holding to acquire one with potentially better prospects.  

Lastly, there are times when it becomes apparent that the original thesis for buying the security no longer applies. For example, during periods of rapid technological change, market leadership can shift quickly as industries become disrupted. No investment is a “set it and forget it”. Investors must stay tuned to company developments and industry news. Times change and so do business outlooks.  

You also mentioned that you have assets which have appreciated in both your registered and non-registered accounts. In the quest for higher returns, investors may overlook their true objective: to generate the most money after taxes. Difference in tax rates and timing matter depending what type of account you hold your securities in. For example, capital gains in an RRSP are not taxed when they are triggered, but all capital will eventually be taxed at the highest marginal rate when it is eventually withdrawn. On the other hand, capital gains in non-registered accounts are taxed at a more favourable rate but are triggered in the year in which they are taken. Here is the secret. If you have mastered the discipline of when to sell, you still should be more active in your RRSP and more patient in your non-registered account. Many investors tend to be opposite, patient with their long-term RRSP investments and more active in their taxable account.  

A key to growing real wealth is to understand how you can leverage the tax system.  This can be done by focusing primarily on investments that are taxed at lower rates like capital gains and delaying the payment of taxes whenever possible. When it comes to taxes on capital gains in non-registered accounts, fortunately the “sooner or later” is usually up to the individual investor. All things equal, opt for “later”. Paradoxically, sometimes the investment with the lower pre-tax return produces greater wealth on an after-tax basis due because the deferred tax obligation continues to compound in your favour until it is triggered. 

The true long-term investor should essentially think of deferred tax as an interest-free loan from the government.  Unlike ordinary debt, investors get the benefit of more assets working for them, but: 1) they have no monthly payments; 2) they are charged no interest expense and; 3) they get to decide when the bill comes due. In other words, deferred taxes have all the benefits of regular leverage, but without any of the downside of debt.  As long as investors continue to hold their investment, they are really getting free money working for them that would disappear if they decided to move in and out of different stocks. We believe that this hidden, but very real form of leverage is a major reason why wealthy people, as well as successful portfolio managers, are reluctant to sell winning holdings of great companies just to buy something else slightly cheaper. 

To be successful over the long-term individual investors need to remain disciplined and gain a better understanding of the emotional and cognitive biases that could be influencing them in the decision to sell. Lastly, it is important to recognize occasional mistakes will be made on the investment journey. The key is to learn from them to do better next time. 

Felix Narhi is chief investment officer and portfolio manager at PenderFund Capital Management Ltd. Inc. in Vancouver.