Have you ever wondered how long you should hold a stock?
I know I and many of my clients over the years have.
So, let’s take a look at what’s the optimal holding period for stocks and when you should consider selling a stock.
We also find out what are the greatest benefits of long-term investing, and how long the average holding period for stocks actually is.
Enjoy!
How Long Should You Hold a Stock
As in so many other cases, there’s no single right answer to this.
Disappointing, I know.
Luckily, there are a couple of factors that will help you decide whether you should keep on holding your stocks.
The ideal holding period depends on your investment strategy and most importantly, on the stocks you own.
What Kind of an Investor You Are
It all comes down to your investing strategy and what kind of an investor you are.
The question of holding time itself is pointless unless you define whether you are, for example, a day trader or a long-term investor.
For me, stock investing is a long-term game, so let’s assume you’re also a long-term investor with a long investment horizon.
The next thing to consider is whether you invest in index funds or individual stocks. If you invest in indices like the S&P 500 or a total stock market index, your preferable holding time is your lifetime.
Not much to discuss there either, so let’s also assume you invest in individual stocks. This is where things get interesting.
The Unbearable Weight of Holding Stocks
So, should a stock picker with a long-term mindset hold stocks from here to eternity?
A simple answer would be that there’s no reason to sell a stock if:
- The company’s fundamentals are sound, and the future looks at least somewhat promising.
- You have no immediate need for the money.
- The risk level of your portfolio is tolerable and it’s in line with your investment goals.
When you sell a stock that’s doing well, you need to find another one that’s doing equally well or preferably better. That means you have to make another successful buy, which is not at all certain.
If a company is doing well and you don’t have a better company in sight, why bother selling?
Unfortunately, many long-term investors begin to chase higher returns and end up trading back and forth with unsatisfactory results. Statistically speaking, it’s not worth it. Buying and holding stocks has proven to be the best way to outperform the market.
Also, one thing that’s often forgotten when selling stocks is that you don’t have to sell all at once. You can sell a portion of your holdings and take your time to see how the situation develops.
Usually, it’s best to avoid extremities. Theoretically, it’s obviously best to buy low and sell high, but it rarely works like in reality.
When to Sell a Stock
While I’m all for long-term investing, the long term doesn’t necessarily mean you hold the stock forever.
Even if you had a portfolio full of quality stocks, there are a couple of reasons to sell a stock that are completely acceptable. Here are the most important ones:
The Fundamentals aren’t what they used to be. What goes up, must eventually come down. Even the very best companies will, at some point, take a dive. It might be due to changes in the industry, in the company itself, or in consumer behaviour.
No matter the reason, it’s vital to follow the companies you invest in. In the long term, a bad quarter or two doesn’t make a difference, but a major problem with the business model most certainly will.
Following the companies you own makes it easier to spot the difference between a temporary and a permanent problem.
An undervalued stock reaches its fair value. A situation that’s typical to value stocks is when you’ve bought an undervalued stock and it reaches your estimate of its fair value. If you planned to sell the stock once its price reflects its fair value, it’s a perfectly suitable reason for selling.
Personal Reasons. As Forrest Gump put it: “It happens”. And it certainly does. Sometimes things go wrong, and you need to sell some of your stocks for money. If it can’t be avoided, there’s no reason to feel bad about it.
What you can do is minimize damage and sell the ones that you think are most likely to become losing stocks. It’s also wise to consider selling the ones with negative returns for tax loss harvesting.
Mergers and Acquisitions. Mergers and acquisitions usually involve a premium that can be quite tempting for investors. On these occasions, many investors decide to sell stocks.
The important thing is to analyze whether the change is good or bad for your stock. If the fundamentals change for the better, the premium may not begin to describe your future earnings.
On the other hand, you might find out that the fundamentals are not going to hold, and the move offers a great opportunity to sell.
Rebalancing Your Portfolio. Adjusting your portfolio is an essential part of portfolio management and a perfectly acceptable reason for selling stocks.
Depending on how much risk you can take, sometimes single stocks can appreciate so much that they start to raise your portfolio’s overall risk level uncomfortably high. On these occasions, it’s okay to sell a portion to adjust your portfolio.
Also, if you feel like a particular stock has become overpriced when compared to its fundamentals, it might be time to consider selling and take home some of the profits.
The Benefits of Long-Term Investments
I took a closer look at the benefits of long-term investing, so I’ll just summarize my previous article here for convenience.
Overall, long-term investing has four main benefits:
Compounding Returns. The first and biggest benefit of long-term investing is compounding returns. When you think about it, a company grows its business over time and eventually it’s reflected in the stock price. If you want your stocks to go up five or tenfold, you need to give them time.
Compounding doesn’t happen immediately, which is why it’s essential to stay invested for a long time. The longer you hold a successful company, the greater the effect of compounding is.
Lower Risk Level. The longer you hold your stocks, the more likely you are to get satisfying returns.
In fact, as Robert Hagstrom demonstrated in his book, The Warren Buffett Way, between 1970 and 2012, the average number of stocks in the S&P 500 that doubled in any five-year block was 29.9 percent. If you’d held stocks for one year, only 1.8% of them would’ve doubled.
This would mean that on average, the longer your holding period, the higher your probability of beating the market average is. This is because, in the long term, the stock market tends to go up.
To put it in another way, the shorter your time horizon is, the more random the stock price movements are due to short-term fluctuations, and thus the riskier your investments become.
Fewer Expenses. When you make fewer transactions, you pay less expenses. Depending on your investment strategy and service provider, the fees you pay can play a major role in your performance if you’re trading shares back and forth.
Tax Benefits. With long-term investments, there are more tax benefits because you don’t constantly sell your winning stocks. Also, depending on where you live, long-term investments may have certain tax benefits like lower taxation overall.
Should You Hold a Losing Stock
Okay, so you bought a stock you thought would do well, but the stock price just keeps dropping.
Should you sell your losing stock?
Well, it depends on the reason why the stock is plunging and how you define a losing stock.
If it’s a fundamental issue like a problem in its business model or financials, and there’s little chance for the company to turn around, selling might be a wise decision.
On the other hand, sometimes stock prices fall without any fundamental reason. During stock market crashes like the financial crisis, for example, pretty much all stocks take a hit. Even the great ones.
What this means is that the company you own may be doing just fine overall and will bounce back when the market settles. For these companies, a drop in prices can be a great opportunity to buy more.
A drop in stock price doesn’t necessarily mean that you’re owning a losing stock.
As you can see, deciding whether to hold or sell a losing stock is a tricky business, and it’s mostly determined by firm-specific factors.
Statistically speaking, individual investors tend to sell the winners and hold the losers, which means that unfortunately, most investors fail to judge the situation correctly.
As a rule of thumb, I would hold a losing stock if there’s a real chance that the fundamentals like the company’s business model will hold. If the company is extremely unlikely to get back on track or has lost its competitive edge, there’s no reason to hold the stock. Not even for sentimental reasons.
How Long Is the Average Holding Period for Stocks
Now we know how long you should hold a stock, when to sell one, and whether you should sell your losing stocks or not.
But how long is the average stock actually held?
As it happens, the average holding period for stocks has dropped dramatically in the past decades.
Nowadays, according to Reuters, the average holding period is about 5 to 6 months. For comparison, in the 1960s, the stocks were held for about 6 to 8 years on average.
In other words, the average holding time has dropped by over 90%.
