Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you advice on specific investment topics. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Selling half of hot stocks that surge helps you guard your profits. But apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.”

As you probably know, our Successful Investor business model has two parts. We publish investment advice through The Successful Investor Inc., and we manage investor portfolios through Successful Investor Wealth Management Inc. (These two companies are affiliated by common ownership; I own both but set them up as separate companies for regulatory purposes.)

This two-business model has advantages for our subscribers. The problems we encounter as money managers, and the solutions we come up with, help us to give our readers unbiased, practical advice. This serves as a counterweight to advice you may encounter elsewhere that is based on misapplied theory, or tainted by conflicts of interest. Knowing when to sell a stock is one of the most important factors in successful investing – it’s almost as important as
knowing when not to sell. That’s why we advise investors to follow a key rule when it comes to rising stocks.

Good problem to have

For instance, an investor recently told me that he sold half of his Canadian Pacific stock after it doubled for him. His broker didn’t object and in fact complimented him on his conservative approach.

Selling half after a double makes sense in a high-risk investment such as a penny mine. In fact, in Stock Pickers Digest (our investment advisory covering more aggressive investments), we routinely advise selling half of any high-risk investment you own that doubles.

That way, you get back your initial stake. This can give you a clearer perspective on what to do with the other half of your investment. If you are too slow to sell speculative stuff, after all, your profits and even your principal can evaporate all too quick. But it’s a mistake to apply this rule to CP.

To succeed as an investor, you need to hold on to your best picks for lengthy periods. If you’re too quick to sell, you’ll never hold a stock that vastly outperforms the market, and you need a few of those to offset the inevitable disappointments.

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You get Pat McKeough’s answers to your personal investment questions when you become a member of his private investment group, the Inner Circle. And you will see his answers to questions other investors like you are asking. In fact, you get virtually all the investment advice Pat has to give. You have access to all of our advisories – The Successful Investor, Wall Street Stock Forecaster, Stock Pickers Digest and Canadian Wealth Advisor – and full access to the members-only, password-protected Inner Circle section of our TSI Network website.

To ensure close personal attention, only a limited number of members can be admitted to our Inner Circle. Click here to see all the privileges you get as a member of the Inner Circle.

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Over the course of several years or decades, you’ll find that of all the stocks you own that vastly outperform the market, most were already well-established when you bought them.

That’s why you need to know the difference between well-established companies like Canadian Pacific, and the more speculative issues you may invest in occasionally. We still see Canadian Pacific as a buy. We would only sell a portion of a client’s holding in this stock if it made up an excessive part of his or her portfolio.

It’s easy to sell too soon or too late. But you’ll limit the cost to you of poorly timed sales if you practice our three-pronged Successful Investor approach. That is, invest mainly in well-established companies; spread your money out across the five main economic sectors; downplay stocks that are currently in the broker/media limelight.

Apply our 5%-10% rule

Every case is different, because each individual has different investment objectives, acceptable risk levels and so on. But you should generally hold on to high-quality stocks, even if they have doubled in price. However, you may want to consider selling part of successful conservative stocks you own if they go way up and come to make up too much of your portfolio — say, more than 8% to 10%. In that case, it may make sense to take partial profits.

In investing for our clients, we rarely put much more than 5% of a portfolio into any one stock. But if a stock does so well that it comes to represent 10% of a client’s portfolio, we at least consider selling part of it, to cut the risk. However, every case is different.

You also need to consider your diversification across the five main economic sectors. If your exposure to the Resources sector now exceeds, say, 30%, then you may want to sell some of your Resource holdings, to cut risk.

To do that, start by selling any lower-quality Resource stocks you own, while hanging on to high-quality issues like, say, Teck, or Imperial Oil.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

When a stock shoots up in price, do you have a specific rule that prompts you to take profits on some or all of the shares? Have you always used this rule, or did you base it on your own experience?