I don't believe in buy and hold until death do you part. The way I see it, the choices you can make are to buy, hold, or sell. It seems crazy to forgo one of your three options simply to adhere to a motto. Flexibility is one of your biggest advantages as an investor. Why give it away for nothing?
By the same token, if you sell too quickly, you can miss out on huge multibaggers such as Hansen Natural
Really, you want the best of both worlds -- a strategy that allows you to both harvest profits and achieve huge returns. That means thinking carefully about both your sell criteria and your hold criteria. These criteria are different for every investor and every portfolio, but I've found the following works well for me.
Hold when: The price changes
Price changes, up or down, don't change a company's fundamentals. If you sell simply because the stock's made you 50% in a short time, you're potentially throwing away a much bigger long-term profit. If the price goes down on no news, the company becomes more attractive, not less. So, it doesn't make sense to sell simply based on price changes.
Before the last presidential election, health insurers were quite cheap. Investors were concerned about the potential of a Democratic administration changing the operating environment for health insurers. Humana
Temporary bad news comes
Bad news will come to every stock, sooner or later. The company will miss estimates by pennies but fall by dollars. In itself, this isn't a reason to sell. If the factors are temporary, and, in the long term the business is still strong, it still makes sense to hold, or even buy.
For example, I bought specialty auto insurer Kingsway Financial
The stock's way overvalued
If a great stock's fairly valued, then it generally makes sense to not sell it. You'll likely know that company better than any new company you add to your portfolio, and it's hard to find great companies at cheap prices, so you should naturally be reluctant to give up the ones you have. But if the company becomes extremely overpriced, then it's time to jettison it -- it will be unlikely to earn spectacular future returns.
A couple years ago, Warren Buffett noted that he made a mistake holding on to Coca-Cola
Sell when: T
he business changes
If you're buying a great business, and suddenly you notice that the business isn't actually that great any more, it can make sense to sell. The key decision point is whether the changes are temporary bumps or the company's business is weakening. I suspect Berkshire Hathaway has been selling H&R Block
The customer base and the margins of its core tax-return business are slowly being eroded by competition from tax software such as Intuit's
There's a better stock to buy
If you're short on money but see an incredibly compelling stock that you absolutely must own, then by all means sell a less attractive stock to raise funds. But before you make the switch, make sure that you take into account transaction costs and taxes. Often it won't make sense to sell a company in which you have large returns, pay the taxes, and put the proceeds into a marginally more attractive stock.
The Foolish bottom line
Of course, all of this assumes that you're buying great companies with solid competitive positions at good prices. But if you're looking for precisely those situations, we can help you at Inside Value. A 30-day free pass will let you see all of our past recommendations as well as lead advisor Philip Durell's two-year review and best picks for new money now. Click here for more information.
Fool contributor Richard Gibbons wonders what's up with the snow in South Africa. He owns shares of H&R Block and Kingsway but does not have a position in any other security discussed in this article. Coke and Intuit are Inside Value recommendations. The Fool has a disclosure policy.