As far as problems in the financial world go, having investments that are doing “too well” isn’t high on the list.
Yet, there are decisions you’ll have to make when everything is going well for you, and making the wrong ones could erase some or all of the gains you worked so hard to earn. Here’s a quick look at some things you want to avoid doing if your investments are doing really well.
Sell Too Early
There’s an old Wall Street axiom that says “you can never go broke taking profits.” And it’s true that profits are not realized until you sell an investment and take the money out, as there’s always the risk that an unrealized gain will go away if you don’t take profits when you can.
But the other side of the coin is that if you sell too early, you might be giving up on an investment that could earn you much more in the future. In the stock market, stocks that are winners often continue to race higher, unless their fundamental story changes.
Not only do increasing earnings translate into higher stock prices, momentum investors often pile into stocks that are winning, pushing these types of stocks even higher. If you sell stock too early when you’re doing really well, you might be swapping a winner for a loser.
Fall in Love With a Stock
The flip side of selling a stock too early is falling in love with a stock and never selling it at all. It’s only natural to feel good when you look at your portfolio and one or a handful of stocks are doing exceedingly well. Not only does it validate your sense that you picked a good investment, but it also no doubt makes you feel good seeing how much money you are making.
But this is where human nature can get dangerous, as it’s hard to part with something that gives you those types of good feelings. Our own human biases make us tend to believe that what works now will always work, and that what’s failing now will always disappoint.
The problem is that if a stock goes up too far too fast, you might watch as those gains evaporate right in front of you. A more prudent move is often to trim back positions that have greatly outperformed with the intention of buying back into them after they give back some of their gains.
Put Your Entire Portfolio Into One Investment
No matter how good an investment is performing for you, it doesn’t make financial sense to put your entire portfolio into a single position. Simply put, the risk is just too high.
As good as the prospects for a company might seem, no one can know with certainty if demand for a company’s products might slow — or evaporate — or whether a business can continue to generate profit growth that will satisfy investors.
A simple quarterly earnings miss can be enough to drop a stock by 20% or more in some cases; and, if investors turn against a stock, the damage can be much more severe — and permanent.
Although it can be exciting to own a single stock when things are going well, if you put your entire portfolio into a single investment, you’re courting disaster. If you’re trying to build long-term wealth, there’s certainly a place for speculative investments — but not at the cost of your entire portfolio.
Take Too Many Short-Term Profits
Investors with itchy trigger fingers tend to sell their winning stocks rapidly, booking profits and heading off to the next investment. But taking too many short-term profits can be a costly game when it comes to tax time.
Investments held for longer than one year are considered long term, and they benefit from the special long-term capital gains tax rate when they’re sold. For many investors, this rate is just 15%, but it can drop as low as 0% for joint filers with taxable income of $80,800 or less.
Short-term capital gains, on the other hand, are taxed as ordinary income. That could translate to a federal tax rate of as much as 37%, and that’s before any state taxes are included. The bottom line is that regardless of your tax bracket, you stand to save about 22% on your capital gains if you can make them long term instead of short term.
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