Holding until a stock recovers
Investors sometimes want to break even on a trade. This may cause them to hold a stock longer than they should, as they wait to get back to a profit position.
The stock market generally rises over time, especially over the medium and long term. But year to year, stocks can be way up, way down or even flat. And despite the market’s performance, you can have an individual stock that does incredibly well or really tanks.
As a rule, I think it’s a bad idea to hold a stock with the goal for it to recover. It may never return to its previous highs, and holding can prevent you from selling and reinvesting the proceeds into something that may perform better in the future.
My take: If someone has money invested in a stock, they should always consider what they would do if they had an equivalent amount in cash. Would they buy the same stock? If the answer is no, then I would say sell it.
Holding to defer taxes
If you’ve owned a stock for a long time inside a taxable account, you may be hesitant to sell it to owe tax. If the capital gain is large, and you’re in a high tax bracket, you could lose 25% or more of the sale proceeds to tax.
However, if a stock makes up a large proportion of your portfolio and you’re overexposed, there’s a risk to deferring the tax. For example, if you’re in retirement and drawing down your investments, that single-stock exposure could become larger on a percentage basis.
I have a client who worked in the pharmaceutical industry and who exercised stock options as an employee 25 years ago. At the time, you could buy the stock and defer the tax until you sold it. The tax deferral over that period has been substantial, but the stock is trading at the same price it was 25 years ago. The client has collected a modest dividend along the way, providing a sub-par return.
Meanwhile, I have another client who worked for a technology company that has performed spectacularly. Their shares represent a large portion of their portfolio. They have needed to make withdrawals from their investments, and their advisor and I have encouraged them to sell the shares along the way. It’s been difficult to sell, and they may have been better off just holding, but risk management may not prove important until the risk does materialize.
