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When It’s OK to “Sell Low”

If there’s one tidbit of investing advice that everybody has heard, it’s that you want to buy low and sell high.

But I can’t count the number of times I’ve heard from people who are making poor investment decisions because of a misunderstanding of how and when to apply the “buy low, sell high” maxim. In reality, there are a number of times when it makes perfect sense to “sell low.”

Tax-Loss Harvesting

As a reminder, tax-loss harvesting is when you sell an investment in a taxable account for a loss (which you can then use to offset capital gains and, subject to a $3,000 annual limit, your other taxable income) and simultaneously purchase another investment that can perform a similar role in your portfolio. (You’ll want to make sure, however, that the replacement investment is not “substantially identical” to the first investment, so as to steer clear of the wash sale rule.)

When you tax-loss harvest, you are “selling low.” But that’s not a problem, because, with regard to your replacement investment, you’re also “buying low” at the same time. And you achieve some tax savings in the process.

Rebalancing Between Accounts

Imagine that you recently realized you could achieve substantial cost savings by:

  • Selling your bond and international stock holdings within your 401(k) in order to switch to a less-expensive U.S. stock fund, while simultaneously
  • Selling your U.S. stock fund in your IRA and buying more of your bond and international stock holdings in order to keep your overall asset allocation the same.

As with tax-loss harvesting, it would be perfectly OK to “sell low” to implement the above plan, because no matter what it is you’re selling low, you’re going to be “buying low” at the same time, in another account.

And, as with tax-loss harvesting, you achieve some savings in the process.

The Investment Doesn’t Belong In Your Portfolio In the First Place

If you have an investment that you’ve decided no longer deserves a place in your allocation (e.g., an individual stock or a mutual fund with unnecessarily high costs), the price of that investment being less than the price you purchased it for is not a reason to keep the investment while you wait for it to “come back.”

The only reason that you would want to keep the investment in your portfolio is if you have a reason to think it will outperform whatever you plan to (eventually) replace it with. And in most cases, if you have already decided the investment is likely to underperform over the long haul, there’s little reason to think it will outperform over the short haul.

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  1. garland whizzer says

    Excellent point, Mike. The right way to look at it.

    Garland Whizzer

  2. I had a investment that didn’t belong in my portfolio. I bought an Emerging Market Bond fund when I heard all the fearful predictions about the US bond bubble bursting. I realized it was a impulsive decision that was not part of my core strategy, sold it at a short term loss since I didn’t hold it very long, and bought the Vanguard Total Bond Market Index Fund which fits in perfectly as part of my portfolio strategy. I learned my lesson not to chase returns with exotic funds that aren’t part of my overall portfolio strategy.

  3. The last point is especially poignant. Many investors hold on to losers too long when they could have cut their losses.

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