Investing: When to ditch and run

August 5, 2005

The decision isn't always clear-cut. These tips can help make it a well-reasoned one.

How long should an investor hold onto a stock? The answer is a definitive "it depends." In a report to his company's shareholders, billionaire investor Warren Buffett stated that, "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." The Oracle of Omaha's declaration might not have been so absolute, however, with companies that, while solid, fall short of "outstanding."

Financial experts agree that there are many different criteria to use when making the buy-or-sell determination. There are times when it's worth holding on while, in other cases, the only reasonable course of action is to cut your losses and sell your shares. You may even decide to sell a winning stock or mutual fund that has been languishing in a slow-growth or no-growth pattern.

Here are a few questions to ask that should help make the hold-fold decision easier:

It does mean, however, that you should take a fresh look at the investment. "Ask yourself, 'Would I buy this today?' " Edelman advises. "If the answer's No, that's a good indication that you might want to sell it." To find out whether there has been a change in management, either check the fund company's Web site or look at its Morningstar Snapshot on http://www.morningstar.com.

Have the managers stayed true to the investment's philosophy? Let's say you wisely selected mutual funds with investment styles that complement one another: value and growth, large-cap and small-cap, etc. You may find that fund managers don't always behave in accordance with the stated objective in the prospectus. For example, they may hoard cash instead of being fully invested. They may claim to be value investors-buying downtrodden companies on the cheap-but, in fact, purchase stalwart growth companies.

If you bought a growth fund dressed in a value fund's clothing, or otherwise didn't get what you bargained for, that may be a legitimate reason to pull out of the investment. Of course, a manager needs to have some flexibility in order to dodge trouble or sit out a storm, but if he consistently or frequently strays from the fund's stated objectives, that's a red flag you need to pay attention to.

In order to make this assessment, you'll need to know whether a fund and its holdings are considered growth or value, large-cap or small-cap, and so on. The easiest way to tell is to look on http://www.morningstar.com where the fund's major holdings will be listed; then plug in the companies' ticker symbols and see how the businesses are categorized as far as type and size.

Do industry developments signal a murky future? Take the following hypothetical scenario: When you bought shares of Harry's Hybrids two years ago, electric cars were perceived as the wave of the future. Recent research, however, has shown that there is a problem with the range of these cars; they may run out of power after only 60 miles or so. Or perhaps one or more industry upstarts have surfaced with state-of-the-art products or technologies that will leave Harry's Hybrids in the dust. In either of those cases, it might be wise to sell your investment.