Plausible Reasons to Take a Loss on a Stock
I am an advocate for long term buy and hold investing. However, this post will play devil's advocate from my normal stance. Most times, we should wait for our investments to recover their value before selling. Here are some reasons that can justify selling out for less than you invested.
You Feel Like You Overpaid
The market tends to swing from bull to bear in a span of weeks or days. Sometimes the market collectively peaks and then drops off big. If you buy the top of a stock and then it deflates, there's no guarantee you'll ever recover your losses. For example in 2020, I bought 5 shares of PayPal at $196. Currently the price sits at $62 and I'm down 68% on those first 5 shares. The difference in the price I entered the position and the current price is a wide margin. I have dollar cost averaged down, now holding 25 shares and will break even at $91. But the buy on the 1st 5 shares will likely be under water for a long time. In this case, I sold two of the original 5 shares at a loss last year. By doing this, I'm mitigating risk and converting a bad buy into tax loss credits. Now, if I was more bullish I'd hold. PayPal has underwhelmed in recent years and the stock has a lot of bad juju. Not to mention, the payments space is very crowded with Apple Pay and Google Pay possibly set to poach PayPal's business. So I wouldn't recommend it to anyone. However, after its 3 year slump, maybe it will make a comeback. I felt like I overpaid when I opened the position, so this is an example where I divested some by taking a loss on some of the shares I bought for 3x the current market price.
Taking Losses Off the Books
When you buy a stock and it goes underwater, those buys will weigh down your portfolio's returns. By selling at a loss, you're taking that loss off your books and using it to lower your taxable income. Divesting limits your exposure if it never recovers.
"Cutting the Fat"
This is a common phrase you hear when people talk about investing and managing their portfolio. The "fat" is your bad positions. By removing it, you leave the leaner, quality "meat", aka the stocks that actually perform well. In a sense, this is a good habit to apply to your portfolio in order to rebalance and mitigate risk.
Selling Businesses That Fail to Execute
Everyone talks about fundamentals in investing. When investors talk about fundamentals, it basically means, is the business executing? Are they making money and executing their strategy? Yeti is an example of a business with a strong brand in drinkware and outdoor coolers that has lacked in execution recently. In 2023, they had to recall a soft cooler product, one of their top selling lines of business. The company has not sparked much excitement, despite their new partnership to sell in Tractor Supply Company stores. They could turn it around, but after opening the position in 2021 and adding over the past few years I chose to divest part of the position at breakeven. So I didn't take a loss in this case, but after reading their earnings call transcripts and reports in 2023, I decided that there are better opportunities than this company. I haven't sold out completely but I would consider selling at a loss if Yeti's woes continue.
Selling Your Weakest Holdings Instead of Your Winners
If you need to sell, let your winners run. If life requires that you sell stocks for money, selling your worst performing stocks is more justifiable than selling your best performers in some cases.
Reducing the Size of a Bet
Taking a little money off the table is a way to manage your risk and exposure to the turbulence of stocks. This is more applicable to taking profits in my opinion. Selling at a loss is another way to achieve reducing the amount of your free cash you have invested in any single stock. If it's not working, I'm more likely to take a small chunk of the position elsewhere, either at breakeven or taking a loss.
Better Opportunities
Even if you are in the red on a stock, it might be a better move to sell out half or all of the position. Then you can take that cash and rotate it into a stock that has better fundamentals and momentum. This is somewhat risky but is a way that you can shift an underperforming stock into a stock that has a better chance of making actual returns on equity.
Conclusion
Buy and hold for a long time should be the default setting for most investors. Most times, we should do nothing. Nonetheless, it's not always the right move. On rare occasions, we should cut our losses and run to a better stock.
Disclosure: not financial advice. The author holds the stocks mentioned.