When to sell a bad investment? Here’s 3 red flags that tell you it’s time to cut your losses

When should you sell a bad investment? On one hand, if you fail to get out of a bad investment, you risk even further losses. The other, if you sell at the wrong time, you could miss out on the upside.

When making the decision to sell a bad investment, it is important to get the timing right to avoid either of the former scenarios. Before we say anything else, it is important that you should never invest more than you are willing to lose. Losing money is bad enough, but losing money you couldn’t lose compounds the pain.

Good life is always possible, even after a tough series of losses, you just have to downsize your expectations.
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Factors to consider when pondering to sell a bad investment

First, it is important to consider both your short-term and long-term goals as well as the underlying reasons for why the investment is dropping in value. Sometimes they can be short-term issues that’ll be resolved in the longer-term, like a cyber attack. At other times, they might be issues that’ll affect the long-term viability of the business.

In cases such as the former (of which Medibank was one example), it may be best to hold onto the investment with an expectation that it will rebound in the future rather than sell the stock. Investors who held on sure did. However, if the decline in value is expected to be prolonged or if there are other compelling reasons to sell it, then selling can be the best course of action. It is easy to say this in hindsight, but stocks like Zoono (ASX:ZNO) that were multi baggers due to demand for hand sanitisers and on the way down as demand waned were blatantly obvious.

Risk/reward considerations

Second, investors should think about their risk tolerance and time horizon for their investments. If an investor has a low risk tolerance and/or a relatively short time horizon for their investments, then they may want to sell sooner rather than later in order to avoid further losses and preserve capital. On the other hand, if an investor has a higher risk tolerance and/or a longer time horizon then they may be willing to wait out periods of volatility in hopes that their investments will recover over time.

Third, investors should also understand any external factors that could mean investment is dropping in value. If the decline is due to macroeconomic factors such as rising interest rates or global economic uncertainty, then selling may make sense as these factors could continue influencing performance over time.

However, if the drop in value is due primarily to company specific issues such as poor management or internal problems like fraud or financial mismanagement then investors should tread carefully before selling. A change in management could turn things around. The challenge is deciding whether or not to trust things will get better under them, you’re taking a blind leap of faith in them.

Reconsider your investment afresh

When making the decision to sell the stock in question, you might wish to ask yourself two questions. First, if you would buy it afresh today. Second, why you bought it in the first place. If the reasons you bought it in the first place no longer hold, you should probably sell the stock.

By the way, when we said about the ‘reasons you bought it in the first place’ we don’t just mean the mere fact that it is down. We’re talking about factors that should have meant the business would perform such as its market share, its industry, competitive advantages or moat.

If these no longer hold, it might be time to sell the stock. On the other hand, if these factors still hold and the company is only sold down due to factors such as general market sentiment, a turnaround is more likely than not and you should hang on.

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