When it comes to investing, the good old "buy and hold" approach is really a solid bet. If you load up on quality stocks and hang onto them for years, there's a good chance you'll come out ahead financially.
Still, there may come a point when you're tempted to sell a stock, and that could end up being a wise choice. But before you unload a stock, be sure to answer these important questions first.
1. Did the stock take a recent hit?
It's one thing for a stock to be underperforming, in general -- consistently losing value instead of the other way around. But a near-term hit is another thing, and if that's the scenario you're looking at, selling could be a big mistake.
Say you're holding a stock whose value has grown or stayed consistent, but after a bad earnings report, its price has suddenly plunged. If you sit tight and give that stock a few months or a few years to recover, its value will come back up. That's why you shouldn't rush to sell off a stock the second its price drops. If you do, you'll lock in a loss that's potentially avoidable.
2. Does the stock provide better diversity in my portfolio?
Having a diverse portfolio can protect you from stock market downturns and help you grow wealth over time. Before you sell off any individual stock, ask yourself if doing so will mean you're no longer invested in a key segment of the market. For example, if Amazon is the only tech stock in your portfolio and you decide to sell it, you'll lose exposure to that segment. So if tech stocks have a general rally, you'll miss out on it.
3. Have I held this stock for at least a year and a day?
When you sell a stock for more than what you paid for it, you're required to pay capital gains taxes. But the amount the IRS gets to charge depends on how long you've owned your investment before selling it.
If you hold your stock for at least a year and a day, and then sell, you'll be subject to long-term capital gains taxes, which max out at 20% for very high earners and equal zero or 15% otherwise. On the other hand, if you hold your stock for a year or less and then sell, you'll need to pay short-term capital gains taxes. These are the equivalent of your marginal tax rate, so if you're very wealthy, you could end up paying a 37% tax rate on the sale of your stock.
Even if you're not a particularly high earner, it still pays to avoid short-term capital gains taxes. Say you're single earning $50,000 a year. Your long-term capital gains tax rate will be 15%, but your short-term rate will be 22%. That's a big difference. Time your sale accordingly to avoid losing money.
It's common practice to sell stocks, but before you do, make sure it's the right move from an investing and tax perspective. The last thing you want to do is sell at the wrong time and regret it afterward.