We all make mistakes, and when it comes to the stock market, you can never be sure what will happen.
If you have individual stocks that appear to be underperforming (consistently), it may be time to cut your losses before those losses stack up even higher.
However, if you believe the market will recover (which it usually does), you may decide to hold onto your stocks and ride out the waves. A lot of people will suggest you do just that, and for the most part, that’s good advice.
If you have index funds, then this is almost certainly what you should do because the market will recover, and if your index funds are down, it means the whole market is down.
But what about the exceptions to the rule? Is there ever a good time to sell a bad investment?
How to decide when to sell an underperforming stock
Let’s say you have a consumer goods stock that has halved in value over the past three years. It’s consistently gone down.
Before panic-selling, take a good look at the wider industry.
If other goods like it are also in decline, then you know it’s the industry, not just your stock. Everything’s doing poorly. This gives you a bit of extra context.
All industries experience declines for a variety of reasons. Maybe the industry is no longer as viable as it once was. Maybe competitors have changed the playing field a bit too much.
But let’s talk about this conceptually to understand when to sell an investment for poor performance. If you pulled up a list of your investments and saw this chart, what would you do?
| Consumer-Goods Stock Price | |||
| Date | Price | Date | Price |
| 6/3/2002 | 33.43 | 1/3/2006 | 23.78 |
| 1/2/2003 | 31.53 | 6/1/2006 | 23.90 |
| 6/2/2003 | 31.01 | 1/3/2007 | 26.29 |
| 1/2/2004 | 35.55 | 6/1/2007 | 27.28 |
| 6/1/2004 | 35.45 | 1/2/2008 | 22.91 |
| 1/3/2005 | 26.45 | 5/2/2008 | 20.61 |
| 6/1/2005 | 28.17 | ||
“Holy crap,” you might be saying. “That’s a crappy stock. I need to sell it before I lose all of my investment!”
Slow down. Instead of freaking out and selling your stock faster than you can scream, “SELL! SELL! SELL!” into a phone, look at the context.
Knowing that the example is a consumer-goods stock, how is the rest of the consumer-goods industry doing?
| Consumer Goods Industry Index | |||
| Date | Price | Date | Price |
| 6/3/2002 | 50 | 1/3/2006 | 38 |
| 1/2/2003 | 49 | 6/1/2006 | 36 |
| 6/2/2003 | 45 | 1/3/2007 | 32 |
| 1/2/2004 | 42 | 6/1/2007 | 30 |
| 6/1/2004 | 44 | 1/2/2008 | 31 |
| 1/3/2005 | 40 | 5/2/2008 | 29 |
| 6/1/2005 | 38 | ||
By looking at the stock and the surrounding industry, you see that the entire industry is in decline. It’s not your particular investment. They’re all doing poorly.
Now, this raises questions about the industry, but it also gives you context to explain your stock’s plunging returns. And just because they’re plunging, by the way, doesn’t mean that you should sell immediately.
That’s part of the reason why buying individual stocks can be a bit of a pain. You need to keep a close eye on them and their respective industries to check their performance. Your money is often better off in an index fund where it’s spread across multiple companies.
