Wednesday 9 March 2011

When to Sell a Dividend Share? (Updated)

Owning high-yield dividend shares is Level 6 of the DIY Income Investor Income Pyramid and can generate a growing income stream. Generally speaking, I would recommend a 'buy and hold' approach to dividend shares - but there are times when you will have to intervene and sell - I just have.

Having said that, selling shares is one of the hardest judgements to get right - so here are some observations to consider.

1) We are hard-wired to make bad selling decisions

 Behavioural research shows that we have two almost instinctive tendencies:
  • we don't like to sell shares that have made a paper loss because that is seen as turning it into a 'real' loss and admitting that the initial 'buy' decisions was wrong. We hope that the price of the share will increase again to what we paid for it.
  • we like to sell shares that have increased in price in order to capture the 'paper' gain - hence the seductive saying: "no-one ever got poor selling at a profit"

A more objective judgement is that 'the share is worth what it is worth' - and a falling share can fall further. Hence many investors have stop limits on the downside, triggering the sale of the poorly performing share and limiting their capital loss.

Experienced investors often say that they sell their 'losers' and run their 'winners'. I wish I could do that but it just doesn't feel right.

2) The DIY Income Investor is interested primarily in income

If a share is continuing to produce the same dividend (and this looks to extend into the future as well),  there is little reason to think about selling it. Some of my dividend shares have fallen 20%, 30% or more and subsequently recovered, whilst continuing to pay a nice dividend over many years.

However, a dramatic fall in price (reflected in a very high dividend yield) may be an indication that something is wrong. Like many, I lost money by not selling Northern Rock quickly enough when the price fell; there was a fundamental reason for the price fall, only I didn't understand it.

3) Have dividends been reduced or or cut completely?

We are holding the shares primarily for the dividend income, so this may be a signal to sell, if you think the company is unlikely to recover. A change in dividend policy is usually an indicator of serious problems.

There is a difficult judgement to make on:
  • the future health of the company - will it recover or not?
  • the revised dividend yield (it may still be acceptable - i.e. within the range of our other investments)
  • the capital loss a sale would crystallise

As I said before: this is a difficult decision.

The Motley Fool has a recent article on whether to be patient or ruthless.

4) When to 'take a profit' - the dividend yield and the 'years of dividend earned' ratio

Because we are interested in income rather than capital growth, an increase in the price of a dividend share may be a signal to sell. This is because, as the price increases, the dividend yield falls - and we want all our money to be working as hard as it can (consistent with not taking too many risks.

One measure I have built into my portfolio spreadsheet is the value of capital increase (i.e. due to an increase in the price of the dividend share) divided by the current annual income (i.e. total dividends for the year). This ratio gives the equivalent dividend-income-years of any increase in capital value.

So if my shareholding brings in £100 (or $100) a year and the value of the holding has increased by £500 (or $500), then the 'years of dividend earned' is 5 - in other words, that shareholding has already earned 5 years of income.

So I use the two measures in any potential 'sell' decision:
  • current (or forecast) dividend yield - which would have to fall below my portfolio average (around 5-6% usually) or, if I hadn't yet sold, my acceptable lower yield limit (around 3.5%)
  • 'years of dividend earned' - which would have to have increased to over 5 years

My recent share sale had the following features:
  • increase in value:  it had climbed to 39%
  • dividend yield: it had fallen to 3.4%
  • 'years of dividend earned: 8.2 years

The sale means that I will have some free cash to invest in a new high-yield investment in the coming weeks - effectively doubling the income from that money for the next 8 years or so.


So have I avoided the potential pitfalls of selling? I'm not sure. But share prices do seem to exhibit 'ups and downs', so capturing some of the paper profits and reinvesting them for increased income may be an effective way to 'ratchet up' the income of my portfolio. Then again, I may have lost the possibility of further increases in the share price!

[Updated May 2013]

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.