The age of easy money seems to be back. Central banks have stated that monetary policy is going to remain easy for the foreseeable future. This has been great for stocks, which have begun to hit new highs almost daily, as investors jump back on the equity bandwagon.
This has caused me to ask myself: Is it time to sell? All these gains could be gone … should I get rid of my shares or hold on for the income?
Don’t sell because markets are hitting new highs
While seeing the market reach new highs can make it seem like it is time to sell, the fact is that markets can go up for a long time before starting to fall back. This fact has bitten me in the past. Expensive valuations and a rising stock market do not mean that the market will inevitably fall. In fact, a rising stock market can feed on itself, with the fear of missing out driving stocks to new, extraordinary valuations.
I am inherently cautious, so I am always tempted to sell out of the market as it begins to climb to new highs. I do not like to lose money. But investors need to keep in mind the opportunity cost of selling. While you do lock in past gains, you also will sell the potential upside the stock market may still have in store.
At the moment, iShares S&P TSX 60 Index ETF (TSX:XIU), an ETF which consists of the largest Canadian companies, is sitting around its all-time highs. It is the oldest, most liquid Canadian stock ETF listed on the TSX. Since it contains most companies that average Canadian investors will hold, it makes a good proxy for the state of those component companies.
At its highs, is it worth selling? Investors should look at their stocks, whether it is a broad basket of companies like the XIU or an individual stock, and decide if it is getting expensive. In the case of XIU, it appears to be reasonably priced at the moment. The ETF has an average P/E of around 15 and a distribution yield of about 2.85%. It is not cheap, but it is not overly expensive either. At this point, you could hold, but conservative investors might consider taking a little off the table.
It pays to have a plan
If you decide to sell, have a plan for how to do it. You could just sell everything and save a little on commissions, of course, but this strategy is a good way to sell at exactly the wrong time. You’d have to be enormously lucky to get it right and ride it all the way down to the bottom to buy again. Repeating this feat is even more difficult.
Instead, there are a couple of different methods to lock in some gains while continuing to ride your shares higher. You could sell covered calls on a portion of your holding, say 20% of your total shares, until they sell. That way, you gain premium income in addition to dividends while you wait.
You can also use a tight trailing stop, perhaps 5-15% below the opening stock price. If you are using an index, like XIU, you will not have the volatility of an individual stock, so you should have time to adjust your stop before the stock sells if you change your mind on selling. Move the stop upwards as the shares continue to climb higher.
Personally, I have the philosophy of waiting until a stock doubles in price before I decide to sell. If I get lucky, and the stock shoots up in a short period of time, I will also get my money back as quickly as possible. After that, I just let the remaining shares ride or buy back in on a notable pullback.
Remember: It’s almost always easier to see when to buy than when to sell
For some reason, it is always easier to know when to buy than to sell. Have a plan to sell. Whether you use options, trailing stops, or set a defined return, having a plan is a great way to keep yourself from selling at the wrong time.
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Fool contributor Kris Knutson has no position in any of the stocks mentioned.