In the most recent Selfwealth Live, I named 5 of my favourite reasons to sell a stock, ETFs-- or any investment. You can find the Selfwealth Live episode below, along with my key takeaways.

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Without further ado, here are 5 reasons you might consider selling a position...

Reason #1 – You need the money

Along with just about every other investment professional, Rask has long held a stance that the stock market, whether via individual shares, ETFs or funds; is no place to park money that may be needed within a 2-3 year time horizon. For example, I wouldn't invest in a fund like Lakehouse Capital or an ETF like Vanguard VDHG (ASX: VDHG) if I knew I might need that money in 3 years. Likewise, I wouldn't invest in shares of Apple Inc (NASDAQ: AAPL) if there was a chance I'd need it in three years. Note: we covered Apple in a recent Selfwealth Live with Dr Anirbna Mahanti.

The reason to keep money away from the market is pretty simple: the stock market is volatile. In 2021, EML Payments Ltd (ASX: EML) shares fell 45% in a single day before the market quickly realised it probably wasn't that bad. Imagine having $10,000 invested in EML and you needed to fund, say, a holiday, new car or hospital visit and you were forced to sell on that day. Ouch!

The reason we, at Rask, take this view with your invested capital is much the same when we avoid debt in our investing, and the reason we like companies without debt: you never want to be a forced seller.

"When major declines occur, they offer extraordinary opportunities to those who are not handicapped by debt“ – Warren Buffett.

Still, all this said, sometimes there are unexpected things that pop up. Terminal illness; severe, expensive and prolonged hospital visits; divorce; changes in short-term goals (e.g. a child needs to go to a particular private school).

The best thing to protect your portfolio from these events actually has nothing to do with your portfolio at all:

1. Have 6+ months of emergency cash set aside (or 2-3 years' worth if you're nearing or in retirement). These funds aren't part of your investment portfolio.

2. Get reliable income protection (you might opt for cover to 65 years of age, to kick in after a waiting period of 6 months)

3. Ensure you, your family and business partners have adequate life/death and other insurances (and a will!)

At the very least, these strategies should buy you time and allow you to focus your selling decisions on other, more logical reasons to exit a position.

#2 – Valuation: the company has shot up past its intrinsic value

This one is pretty obvious and often talked about¦ but it probably a mistake to focus on this too much. Still, it's important.

We've covered valuation theory at length in the Selfwealth Live sessions and in our free share valuation course and highly regarded Value Investor Program (note: Selfwealth users can get free access to all beginner-level Rask courses, please keep an eye on your email inbox).

Basically, investors and analysts (like us) use models such as Discounted Cash Flow (DCF) analysis to determine a fair price' of a company. We then compare the intrinsic value (IV) to the stock price of the company. Inside the Selfwealth trading platform, you can see analyst valuations and forecasts, pulled in from Refinitiv.

I'll play a straight bat with this one: I think it'd be a mistake to sell companies solely on valuation.

Why?

There are a few things you should know about valuation:

1. Valuation is at least as much art (thumb-sucking) as it is science

2. In my view, generally correct' is far better than specifically wrong' because even if your valuation model is looking fly, there no guarantee the market will bid up the stock price to make it useful

3. Fund managers, analysts and other commentators use valuation as a 'get out of jail free' card when really they sold for other reasons.

If you want to understand the limitations of valuation in practice, jump onto Twitter and follow a few short sellers.

If you're a long-time listener of The Australian Investors Podcast (thanks!), you'll realise that when I have short sellers on the show they often say we don't short on valuation alone. Translation: there are zero guarantees the market will agree with your valuation anytime soon.

"In the short-run, the stock market is a voting machine. Yet, in the long-run, it is a weighing machine.“ – Ben Graham

#3 – Opportunity cost: you think you can get a better return elsewhere

Similar to my notes on valuation above, there a cost with everything we do. By choosing to hold EML Payments shares at a full value, we might be giving up the opportunity to buy Xero Limited (ASX: XRO) shares when they're cheap, or vice versa.

Hamish Douglass, the renowned fund manager from Magellan Financial Group (ASX: MFG); and Chris Judd, the former AFL superstar turn private investor; both told me they think of their portfolio as a sports team, with substitutes on the bench (i.e. your watchlist) waiting for a spot on the field.

For a fund manager like Hamish, I think this is a neat analogy. But keep in mind a fund manager like Hamish may have different priorities and incentives to you.

For example, we should consider the average fund manager has a very high portfolio turnover and an average holding period of 7.4 months.

Nonetheless, selling a share because you find a better idea is one of the finest reasons I can think of to exit a position. However, it’s not always clear cut and you must make sure you find a new opportunity that outweighs the tax and fees involved in selling.

Keep a journal of your trade decisions because I’ve found a lot of new investors (i.e. those with less than 5 years’ experience) find themselves selling, for this reason, more often than they’d care to admit. After five years, the best new investors I come across can count the number of shares they’ve sold on one hand.

“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all… Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about. So you’d do so much better.” – Warren Buffett

#4 – You need to rebalance your portfolio

In professional investing circles, the most common approach to portfolio construction — how you build your portfolio — is to use a technique known as Strategic Asset Allocation or ‘SAA’, together with something called Tactical Asset Allocation or ‘TAA’.

This is also called the “Core & Satellite investment strategy“. Indeed, another way to think of SAA is the ‘core’ of your portfolio, while the TAA could also be known as the ‘satellite’, as I explain in the video below:

How does this relate to selling?

Investors use their SAA, which is often written down in an Investor Policy Statement (IPS), as their ‘bumper bars’. Like a bowling ball bouncing off a bumper, the SAA keeps you going in the direction you want, regardless of your short-term mindset (fear, greed, envy, etc.), which often changes due to market conditions.

Good investors will use their SAA and rules contained in their Investor Policy Statement to set ‘rebalancing rules’. For example, if you want to invest 80% in growth assets like shares, but after two years you notice your portfolio mix rises to 88% in shares and 12% in defensive/income assets, you could have added a rule in your IPS to say:

• “I can rebalance whenever my portfolio is 2.5% away from my SAA”

• “I must rebalance whenever my portfolio is 5% away from my SAA”

I have found that these rules, written in advance, save investors during market crashes. They save investors from letting the pendulum of fear and greed flip their life-long wealth goals upside-down. Again, these are safety bumpers.

For example, during the crash of the GFC and again in 2020, when COVID first struck, investors jettisoned their shares and stuck extra capital into cash/savings accounts. That was the exact worse time to do it. Instead, what they should have recognised is: ‘my defensive assets have done their job, but I’m under-invested in stocks — I’ll rebalance by buying more shares’.

Had those same investors sat down to carefully think about their goals and risk tolerances, and written out their investor rules, they wouldn’t have done that. These rules help you make scary, good decisions at the time you need them most.

This reason for selling, #9 on my list, is tied for the most important reason to sell a stock or investment. It’s only second to the #10 reason investors sell shares because this is a portfolio decision rather than a company-by-company decision.

#5 – Thesis break

Last, and certainly the most important is thesis break: the only real reason I sell shares in a company.

A thesis is your reason for making an investment and owning it. This, obviously, must be formulated before buying into an investment.

There is an easy way to explain what a thesis is and how to know if it’s broken. Just ask yourself a question:

Why do I own the stock/ETF/thing?

When a friend asks you, “why do you own that investment?”, what is your response?

“PayPal is the world leader in payment gateways and payment apps. It makes it super-easy and secure to buy stuff online, sell things you don’t need and transfer money to people. It’s becoming more and more popular.”

Humans tell ourselves stories to help us break down complex ideas, and these can lead investors astray. However, the important takeaway from the above is that by saying those few sentences, you have identified the ‘essence’/value proposition/central question of why the company exists; and you have determined why you own it (it’s becoming more popular).

If the narrative changes one year from today, for example, when prompted you say: “More people are using Apple Pay instead of PayPal these days”, your thesis might have been broken.

The problem is narrative bias kept bottled in our heads can be a fairweather friend. If you do not write down your thesis it will be easily forgotten or twisted to fit a changing circumstance — you will never truly know if your thesis is broken. 

There is a reason the best investors to have ever lived — Ben Graham, Warren Buffett, Charlie Munger, Peter Lynch, Howard Marks, etc. — are brilliant writers. It’s not because they love the subtle tremble of a ballpoint pen across paper. It’s because it must be done.

To think, and invest, clearly, you must formulate your thesis and write it down. This thesis is your current self protecting your future self.

A thesis is your repellent to the monkey brain. A peg when your brain farts.

A thesis is formed from your intellectual hard work. Hard work is what few investors do (including most professionals). It’s what defines great investors from great analysts, great investors from the mediocre.

Of course, this hard work is why Rask Invest exists. We do the work and write down our thesis for every investment, so you don’t have to. Over the next 1o-20 years, we believe this will guide us, and our members, down the pathway towards lifelong wealth.

Thanks for reading! I’ll see you at the next Selfwealth Live!

Owen Rask