In general, most of us are averse to booking losses. So, we don't sell. But, there are reasons to consider selling. Why?
Firstly, if you believed that the price is likely to settle at a value that is much lower for the foreseeable future or if you believe you have better investment opportunities, then selling makes sense. A hundred dollar stock is better sold at $5 than not sold and reduced to zero.
Another view is the tax relief view. Imagine you have a portfolio whose cost was $100. Now the market price of the portfolio has dropped to $20. And, you are subject to a tax rate 15% on your gains and losses on your portfolio. If you sell, provided you have gains to offset your losses, or are permitted to carry forward the losses, you essentially get a tax benefit equal to $12. What does this mean?
- Well, if the value of the portfolio drops further you have capped your losses at $68.
- If the value of the portfolio starts rising, we can buy it back at a price less than $20 which would yield a net gain on the transaction, but even otherwise, as long as we buy it buy before the price touches $32, we would essentially protect some of the upside.
Now these calculations don't factor in transaction costs or volatility. All said though, you should consider selling if:
- The decline in the stock is not part of normal volatility, but part of a prolonged downturn or a permanent decline in value, and
- There are better investment opportunities, or there is a real risk of the value of the portfolio settling at a level that is much lower than it is currently, or there is a possibility of getting tax relief.