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How Do I Know if I Should Buy, Sell or Hold?

"Buy low, sell high" is a favorite quip uttered by actors playing Wall Street tycoons in movies. It would be great if we could know that when we buy a stock it is low in price and that we will be certain to make a killing later when we sell it. Unfortunately, such knowledge is impossible to come by.

When people talk about buying, selling and holding, they are really talking about two different things: whether they should buy, sell or hold classes of assets, such as stocks, bonds and cash; and whether they should buy, sell or hold stocks or bonds of individual companies.

Buying, Selling and Holding Asset Classes

When investors buy, sell or hold, asset classes, such a decision should be part of a long-term and focused financial plan. For example, a young couple decide that they want to fund their child's higher education, they would figure out how much they could afford to invest each year or month. Generally, such couples may put the majority of the funds into stocks or stock funds because stocks generate the highest returns relative to other investments, such as bonds or cash. If the child is, say, two, they may be investing, or buying regularly in stocks or stock mutual funds, for example, buying $200 worth of stock each month, based, of course, on their income and whether they want to send their child to a private or public university. They may be buying and holding stocks until the child reaches the ages of 13 or 14.

At that point, with only four or five years before they need to pay tuition, they may be gradually selling some of their stocks and moving into medium-term bonds or bond funds, which are less volatile than stocks. In effect, the couple is reducing the risk that their stock market gains could be hurt by a sudden downturn in prices.

By the time the child is in college, they may have sold all their stock and have their proceeds in a combination of cash and short-term, high quality bonds, such as government bonds, in order to make sure that they can indeed pay the expense.

Clearly then when buying, selling and holding asset classes, the key driver is achieving the long-term financial goal.

Buying, Selling and Holding Individual Stocks

Figuring out when to buy, sell and hold individual stocks is much harder to determine. In general, financial professionals advise a long-term buy and hold approach, meaning that investors should carefully research companies they are interested in investing in and once they buy them, hold them for at least 10 years or more.

Many studies have shown that when investors try to time the market, that is guess when a stock is low or high and try to make a profit on the difference, they bet wrong. Another problem with buying and selling stocks quickly is transaction costs. In other words, even if there was a way to time the market and make a profit, costs such as broker commissions, taxes, etc. would eat away at those gains.

Many investment philosophies offer general rules when to buy, sell and hold. For example, value investing suggests buying companies when their price-earnings ratio is below that of the market as a whole and their competitors. If and when the company's price-earnings ratio rises above the market as a whole and its competitors, than that company is considered to be overvalued, and an investor should consider selling it and taking profits.

Some investors overreact to bad news about their companies and drops in their share prices. They think to themselves "everyone's dumping this stock, I should too." That may be a mistake. Investors need to analyze and decide for themselves whether a company that is seeing its share price drop really is in trouble, or is just having a minor setback.

That is no easy thing to decide. Some investors, in fact, talk themselves into believing that a company and its stock price will recover when in fact, the company will likely go under. These investors don't want to admit to themselves that they will incur losses and ride the stock down to the very end.

To reduce the tendency to react emotionally to changes in share prices, investors need to remain calm and collected and rely on the facts, as outlined in corporate earnings reports, news articles, etc. Another way to remain calm is to talk about your investments with a financial professional or join an investment club, where you'll get a variety of opinions on what you should do.

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