ERIK GUSTAFSON, like many Americans, sold a few stocks in recent months, boosting the cash portion of his financial portfolio from a normal level of about 5 percent to around 9 percent. Mr. Gustafson weeded out some issues posting negligible earnings growth. But by obtaining cash, he is now better able to buy higher-performing stocks.
Gustafson is manager of the $60 million SteinRoe Young Investor Fund, a mutual fund. But whether a person is a money manager monitoring millions of dollars in assets, or an individual investor with a modest portfolio, it is crucial to know when and how to sell, Gustafson says. That is particularly true, he reckons, in a financial climate such as now, when economic growth is sluggish, market volatility is high, and there is the possibility of a downward ''correction'' in stock prices.
''Selling is the toughest decision you can make in investing,'' says Maury Elvekrog, president of financial management firm Seger-Elvekrog Inc. in Birmingham, Mich. ''We believe in long-term investing, rather than market timing'' - buying and selling to maximize profits on the basis of speculation on future price patterns. ''But a little selling now and then can be important, so long as it is done with moderation.''
When it comes to selling, the three financial markets to watch, agree most experts, are stocks, bonds such as corporate or municipal issues, and US Treasury issues, where the frequency of new issues may change the underlying value of older issues, particularly in the case of long- or intermediate-term bonds.
Stocks. With equities, Mr. Gustafson says, you have to watch the performance of the specific issue in relation to a broader measurement, such as the Standard & Poor's 500 index. When he sees a stock drop 15 percent in value relative to the S&P 500 for a trailing 12-month period, he then wants to know if the downturn reflects fundamental problems. Or is the drop explained by unique factors, such as the firm's market segment being in momentary disfavor? If company prospects appear sound and the issue offers potential for future earnings growth, then the stock is retained, he says.
Over time, the average earnings growth of companies listed in the S&P 500, Elvekrog says, has been about 7 to 8 percent a year, with a dividend yield of about 4.5 percent. If a particular stock drops below those levels, yet has a high price-earnings ratio - say, above 25 - the stock might be a candidate for chucking, he says.
Turmoil within a company, or the lack of clear product objectives, may also be warning signs, Elvekrog says. But ''stocks that have been consistent performers over time'' - such as Coca Cola, McDonald's, or Walt Disney Company - should be held, ''even if they occasionally underperform.''
The mechanics of selling a stock are easy, says Bryan Luther, a broker-dealer with Merrill Lynch & Co. in Peoria, Ill. You simply call in your order to sell, and the broker sends a sell signal to the appropriate exchange, such as the New York Stock Exchange. The sale can occur in minutes. If you want to sell at a specific price - say $100 for a stock you bought at $80 - the broker puts in a command to sell when the stock edges up to that price. You can do the same on the down side - ask to sell when it hits a certain new ''low.'' If you hold a stock, but are not listed with a broker (which could happen if you inherit a stock), you must usually go to a broker and open an account. The broker will then sell it. Sales charges typically run between 1.5 and 2.5 percent of the amount of the sale, Mr. Luther says.
Bonds. Selling strategies can differ for bonds. A few bond technicians don't like declining interest rates, since lower rates limit current income. Other technicians are horrified by rising rates, since bond prices are pushed down, reducing total return (the combination of interest income and price appreciation). Almost all bond technicians, however, agree that rising inflation is the culprit to watch. When the spread between inflation and your particular bond yield narrows significantly, then it may be time to sell, says Paul Williams, research manager with the bond house John Nuveen & Co. in Chicago.
A bond should ''retain its creditworthiness,'' pay a decent yield, and not be subject to imminent ''call,'' that is, redemption by the issuer, which might result in a loss for the bondholder, says Sharon Alister, senior vice president with the investment firm Dean Witter Reynolds Inc. in Chicago. Ms. Alister also urges her clients to shop for bonds that are candidates for ''prerefunding.'' Prerefunding is when the issuer collateralizes (secures) the bond with US Treasury issues to cover interest and principal up to the first call date and makes a guarantee to call the bond at that date. A bond, once prerefunded, has a ''pop-up'' in price, she says. Thus, by selling well before the call date, a person can capture the rise in the bond price.
Selling a bond is easy, she says. You call your broker-dealer, who will quote you a ''bid price.'' You say yes or no, and if yes, the dealer sells your bond.
US Treasury issues. Treasury issues - bills, notes, and bonds - are sold far less frequently than corporate or municipal bonds, but sometimes for similar reasons. There are two ways to sell Treasuries, says agency spokesman Peter Hollenbach.
1. If the issue is held in your account at a private institution (such as a bank), tell the institution that you wish to sell. You will be quoted a price, which depends on current market interest rates. The institution will usually buy the instrument.
2. If the issue is held in an electronic account (called ''Treasury Direct'') with the US Treasury, you will need to transfer the unit to the secondary market, meaning a financial institution or broker dealer. Ask for a transfer form. You will need the electronic transfer number for the institution, along with your account number.