Sunday, July 30, 2006

There are a couple of good reasons for selling an individual stock.

It may be a loser that is doing significantly worse than the rest of its sector. But it also could be a winner that has gained so much that it now represents a dangerously large chunk of an investor's assets. Think tech stocks in the 1990s.

This can be a particular problem with company stock programs -- employees end up doubly vulnerable to a firm's fate because they depend on it for their livelihood and because it represents a large chunk of their savings. The classic example occurred in late 2001, when Enron Corp. declared bankruptcy.

One rule of thumb is that in a diversified portfolio, no one company should represent more than 10 percent of the holdings, said Kyle Meyer, a Purcellville financial planner who works with middle-income investors.

Once an investor has decided to dump a stock, there are a couple of ways to do it, depending on the size of the holding and whether it has increased in value since it was purchased.

If a loss is involved, the investment isn't particularly large and the investor has lost faith in the stock completely, the best course is probably to sell right away. Most brokers charge commissions of less than $20, so there's no big expense. (Transfer the stock to a discount broker such as E-Trade or Charles Schwab if the broker who helped buy the stock wants to charge more.) Investors can also write off the loss on their taxes. (The IRS allows investors to balance a loss with any gains and then take up to an additional $3,000 in any given year. Excess losses can be carried forward to balance the next year's capital gains.)

For larger holdings or for stocks that have done well but whose investment size needs to be pruned, reverse-dollar-cost averaging may be a worthy strategy, said Paul Sanchez, a McLean financial adviser. Under that method, investors sell off chunks of the stock at regular intervals, so they will benefit if the share price continues to rise, won't suffer if the broader market happens to be down on the day they want to sell and won't spook the market with a large dump of a thinly traded stock.

When an investment has done well, the choices are a little more complicated because a sale will incur sizable capital gains taxes. It probably makes sense to sell at least part of the investment, especially if there are capital losses to balance out the gains.

But another choice is to use put and call options to hedge part or all of the investment. These strategies essentially involve shorting the stock even while hanging on to it and aren't for the novice investor, but a good investment professional can help build a package to protect from big losses if the stock happens to fall sharply, Meyer said.

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