Skip to main content

If an investor is selling for tax loss harvesting, they should try to set up a switch trade, so they can sell and exchange their position with a similar investment that is required to hold for more than 30 days, in order to declare a loss.Spencer Platt/Getty Images

Are you a professional financial advisor? Register for Globe Advisor and then sign up for the weekly newsletter on our newsletter sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know.

Investor psychology can be a powerful force. No matter how investors fill out their risk tolerance assessments, when faced with a prolonged market downturn like the one we have seen this year, many will be considering exiting a portion of their investments.

When it comes time to do some selling, it’s important to keep in mind the best investment exit strategies and how to implement them.

“The selling of securities in any account should always comply with a long-term investment strategy and not be a knee-jerk reaction to volatile market conditions,” says Mary Hagerman, portfolio manager and investment advisor at The Mary Hagerman Group with Raymond James Ltd., in Montreal.

“It’s important that investors do not act impulsively when selling. They need to step back from the markets and have a good answer to ‘Why do I want to sell now?’”

Ms. Hagerman notes that sharp market downturns are not necessarily good times to sell. Rebalancing might be better if the overall asset allocation still makes sense for the long term.

Instead of selling a specific investment for cash, Ms. Hagerman advises considering staying invested but looking for a different or more diversified option that has better potential when the markets turn around. For instance, selling a single stock holding in technology and buying a tech index such as the Technology Select Sector SPDR Fund XLK-A or Invesco QQQ ETF QQQ.

Ms. Hagerman also has some specific tips and strategies for exiting investments.

“Never put in a sell order on the market open or too close to the close, especially for ETFs (exchange-traded funds),” she says. “Give the markets some time for price discovery.”

For large orders and in very volatile markets, she advises setting a limit price, and also keeping in mind the underlying market. For example, European ETFs should be transacted early in the day before their markets close, if possible. Also, if the investment is hedged, keep in mind the direction of the exchange rate when selling – it could be working for or against the trade.

For equity and fixed income, be mindful of ex-dividend dates and income distribution dates that could affect the trading price. Also, any geopolitical events or important announcements that might be pending and could affect pricing.

Ms. Hagerman likes to look at market technicals such as 200- and 50-day moving averages and follows the advice of her firm’s head technical analyst for the overall direction of the market when looking to rebalance or liquidate part or all of a position.

“There is often a bounce right after a big selloff that gives a better exit price,” she says.

Another technique Ms. Hagerman mentions is that if an investor is selling for tax-loss harvesting, they should try to set up a switch trade, so they can sell and exchange their position with a similar investment that is required to hold for more than 30 days, in order to declare a loss. The investor can then switch back to their original holding if they so desire.

Setting stops at inflection points

David Burrows uses a disciplined and systematic approach to selling in his role as chief investment strategist at Barometer Capital Management Inc., in Toronto.

“We identify a price below our entry level where we would stop ourselves out in the event that it does not work out as expected,” he says. That is, a pre-determined price to sell if the stock falls to that level.

“In effect, it quantifies our risk budget on each position and protects against a small mistake turning into a big one.”

Mr. Burrows notes his firm sets stops at what they see as a inflection point where a position goes from being in a clearly defined uptrend to a downtrend. And when positions breach these inflection points, they choose to exit. Barometer also resets stops over time to higher levels.

From a tax perspective, Mr. Burrows says that by quickly selling weak positions and holding winning positions, his client portfolios build a taxable loss pool that can offset future gains.

“We tend to make the business decision first and tax decision second. Better to pay tax and protect a gain than to hold a failing position in order to save tax,” he says.

Should you ‘throw in the towel?’

When it comes to exiting investment positions, sometimes the best first step is to determine whether you should be selling at all.

“I certainly recognize that investors are psychologically primed to want to throw in the towel the deeper the downturn in markets gets, but logically, the depths of a downturn when recent returns have been the weakest is the worst time to exit an investment and is the exact point in the cycle when future returns are the best,” says Brian Madden, chief investment officer at First Avenue Investment Counsel in Toronto.

Mr. Madden says a better approach is to have a written asset allocation policy, and rebalance it quarterly, or at least annually. This approach would have the investor partially selling richly valued and/or highly appreciated assets closer to peaks in the cycle and adding to them closer to the depths of a downturn.

“At the risk of oversimplifying, there’s only two reasons to sell a stock – you were right, or you were wrong,” Mr. Madden says.

In the first case, a selling decision should be based on a reassessment of the fair value of the stock and likely catalysts for its future growth. In the latter case, he says “you must coldly and unemotionally” revaluate the potential value of the shares, as well as their growth prospects. If at that point you conclude that the rosy future you once envisioned for the business is no longer feasible, it’s time to “rip off the band-aid” and sell the shares.

For more from Globe Advisor, visit our homepage.