A good plan for investing is to buy quality stocks and hold them for many years. But sometimes, plans need to change.
If you have a stock in your portfolio that’s been underperforming, you may not be sure how to approach it. Do you wait things out and hope for the best, or dump that stock and deal with your losses? Here’s how to know.
Temporary versus long-term blips
There may come a point when even the best stocks in your portfolio see their share-price decline, either individually or in conjunction with a general stock market correction or crash. In the latter scenario, your best bet is to do nothing.
When the broad market gets sluggish, it’s not necessarily reflective of an issue with a specific stock. So it generally pays to leave your investments alone and wait for the market to recover.
But let’s assume it’s just a single stock in your portfolio and its value isn’t where you’d like it to be. If that’s the case, you’ll need to do some digging to see if there’s a specific reason that stock is suddenly worth a lot less.
Maybe the company’s most recent earnings fell short of expectations. Or maybe regulatory changes are making it so that a given company will now have to spend a lot more money on compliance and may be limited in how it can sell its products.
There are a host of reasons why a given stock might take a dive, but understanding the driver can help you determine whether the situation is likely to get better or keep getting worse. In the case of lackluster earnings, it may be that a company had a bad quarter after several quarters of growth. That’s not necessarily something to get anxious over, whereas multiple quarters of missed earnings could be more of a red flag.
All told, your takeaway here is that if a stock’s price has gone down, it’s important to assess whether that movement is likely to be temporary versus ongoing. And if it’s the former, you may want to keep the faith — and keep that stock.
Dumping losing stocks strategically
If you determine that you’re better off unloading a stock when its value has declined, all is far from lost. That’s because losses in your investment portfolio can be used to offset capital gains.
Say you sell a stock and take a $5,000 loss in the process. If you’re sitting on a $5,000 gain, suddenly that gain is wiped out from a tax-liability standpoint. And if you’re looking at a loss that will exceed any gains you’re sitting on or planning to take, up to $3,000 in capital losses can be used to offset ordinary income.
Plus, if you don’t take your entire loss for the tax year in which it’s incurred, you can carry the remainder into future tax years. Say you’re looking at a $10,000 loss and $5,000 in capital gains. The first $5,000 of your loss will offset your gains, and the next $3,000 can offset some of your ordinary income. The remaining $2,000 can be carried forward and used during the next tax year.
It’s more than possible to buy a stock, only to have it lose value. Before you rush to dump a stock in that situation, think about whether you’re looking at a temporary versus long-term setback. And then, see if it’s possible to use a loss to your advantage.
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