Selling when you need to sell

If you have a need to sell because you want to finance a holiday or pay for a wedding, then having a diversified portfolio may provide greater options as to which shares to offload.

I would first consider any shares that have limited or inadequate performance, and offload them first. I would then look, if necessary, to part-sell those shares that have high P/Es and are performing above historical P/E averages.

These are the ones which are more likely to be hit hardest if there is a hiccup in their operations, or if there is a general downturn.

On the other hand, you may need to sell to protect capital. This scenario may come into play when a stock you have purchased for all the right reasons tumbles in price for some unforeseen circumstance and looks unlikely to recover in the short term.

I sell this share if its loss in price at any point in time exceeds two per cent of my total portfolio value. The percentage you might set will depend on the size of your portfolio. The smaller the size, the smaller the percentage.

The reason why I would sell is that protection of capital is a prime concern and should not be overlooked as a consideration. Declaring the loss on the next tax return, if you are in a position to do so, helps to reduce the pain.

Keep in mind that a share that drops 50% in price from $10 to $5 needs a 100% turn around in price to recover to the old level.

A good example that taught me a lesson in the past, and the only time I needed to invoke this capital protection strategy - and didn't, was Cochlear (COH), the Australian stock-exchange (ASX) listed bionic-ear company.

I bought in at $48 and it climbed to $49 and then plummeted due to what I recall was a meningitis scare. I held on through the $30 mark and beyond my 2% rule believing that the company had excellent prospects.

The share price kept dropping to $19. This was an excellent price to buy back in if I had preserved my capital by selling out in line with my two per cent rule - since it turned out that the meningitis scare related to a competitor.

Fortunately I had sufficient cash reserves to buy in again at $21, but if I didn’t have the spare cash, I would have had to endure the opportunity cost associated with its share-price recovery into the $70 range! ... so I was right about the excellent prospects of the company.

Selling for a loss is psychologically difficult, as it is a test of our self-esteem ... and it is too easy to hold on to losing positions when there is a need to sell. No one wants to admit that they are a loser; but it is better to be a small loser than a big one!

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