“Goodbye” is often the hardest word. You can get emotionally attached to an investment, just as you can with a person. It’s hard to bite the bullet with an investment and call it quits. Sometimes your head tells you one thing, but your heart another.

However, as an investor, you need to listen to your head, and remain coldly rational about your holdings. When a stock, bond or mutual fund has soured and it’s time to sell, don’t agonize over it. Dump it!

In this context, the legendary investor Warren Buffett probably gave the best advice: “You want to be greedy when others are fearful and fearful when others are greedy.”

Below is a primer on how to tell when the time is ripe for a break-up. Several other complex factors come into play that are singular to the investment, but these ground rules have the benefit of universal applicability. Just tell your broker: “Hey, it’s not you. It’s me.”

• When to sell a stock.

Any equity that you now hold that you don’t consider to be a “buy” candidate should be a strong candidate for sale.

If the stock has loyally served you well in the past, you may be reluctant to sell it. But put on your analyst’s cap and ask yourself: If I had to rate this stock, would I give it a buy, sell or hold? If the answer is sell, then follow your own advice.

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To make the decision easier, remember that you don’t have to dump the entire stock holding. If you still think that the stock might decline but it still has long-term potential, at the very least, pull back your position.

You might, say, sell half and then put off making a decision about the other half. Nonetheless, don’t just hang onto a stock that you’ve soured on, simply out of inertia or sentimentality.

When first buying a stock, smart investors establish a specific “buy up to” price target or a range within which they would consider selling the stock. As part of every stock purchase, include your own analysis as to what the stock is actually worth.

We tend to look for stocks with a current price that’s at a discount to our estimated value. For example, let’s say you’ve set a goal of selling the stock as soon as it has doubled in price—a worthwhile goal that implies that you think the stock is undervalued by 50%.

In addition to monitoring the stock’s price, you also should keep an eye on the health of the underlying business. If certain key fundamentals such as revenue, earnings and cash flow markedly decline, you should be proactive and perhaps sell before the stock price takes a dive.

Then there’s the so-called “25% rule.” Historically, the stock prices of strong companies have started to pull back after a rise of about 25%. When a stock has reached this threshold, consider locking in at least partial profits.

• When to sell a mutual fund.

If your fund is underperforming, don’t be impulsive and act too fast. What happens all-too-often is that an investor picks a mutual fund because of its stellar past performance, but quickly becomes disillusioned when the first couple of quarters are disappointing.

He or she dumps the fund out of frustration—only to see the fund eventually live up to its potential and its historical performance.

That’s why, when a fund that seemed good on paper starts to go south on you, the first thing you need to figure out is why. Compare the fund’s average performance to similar funds and examine the overall context. Maybe the problem isn’t with the fund managers but with that particular sector.

Always keep in mind that mutual funds are not synonymous with equities. A stock market drop doesn’t automatically translate into a “sell signal” for the fund. Stocks are individual investments with rates of return linked to what the market will bear. They’re governed by a “buy low, sell high” dynamic.

But contrary to a common misconception, mutual funds are not singular entities—they are baskets of financial instruments chosen by managers according to a pre-established investment strategy.

The clear advantage with a fund is diversification. A decline in one or more of the fund’s holdings is typically offset by other assets in the portfolio that are either holding firm or rising.

Because a mutual fund can represent diverse markets, relying on market timing to sell your fund is misguided. Moreover, because mutual funds are designed for long-term gains, a rate of return during the first year or so that’s disappointing is not a sufficient reason to dump the fund.

One potential sell signal is a major outflow of fund dollars. Mutual fund managers prefer to stay fully invested within their investment mission. When a fund undergoes a high level of redemptions, the managers might be compelled to keep more cash on hand to meet these redemptions. In turn, this cash is not available for investment in the stocks, bonds or other assets that the fund is supposed to emphasize.

Sometimes, patience is the best counsel and all you really need to do is ride out the turbulence. The time to sell is when your fund consistently performs poorly, compared to its peers.

• When to sell a bond.

Don’t buy a bond, unless your intention is to hang onto it until it matures. That said, situations might arise in which you need to sell bonds to recalibrate the asset allocations within your portfolio (or to quickly raise cash). The most persuasive reason to dump a bond is that the issuer, whether a corporation or a municipality, is unraveling at an accelerating pace.

Many investors make the mistake of thinking that bonds are inherently safer than stocks. But the fact is, low-rated bonds can be just as risky—if not riskier—than stocks. The higher the bond’s return, the higher its risk. Conversely, safer bonds confer lower returns.

When investing in bonds, your return is linked to their credit rating as well as market fluctuations. Bond choices range from the highest credit quality U.S. Treasuries to speculative bonds that are below investment grade. For most investors, it’s preferable to put money in bonds that are highly rated or U.S. Treasuries.

However, if your bond has a lower rating and you find yourself in that unenviable position of watching its issuer deteriorate, secure the services of a savvy broker, to make sure that you get the best possible price.

Regardless, remained informed at all times about the credit status of your bonds. A common mistake is to put bonds on autopilot, but that’s a bad move because circumstances surrounding them can change.

If you decide to sell a bond before it matures, you’ll receive the prevailing market price, which may be lower or higher than the original price. The value of bonds fluctuates with the market, in the opposite direction of the movement in interest rates. Bond funds’ values fluctuate in the same manner.

Through it all, always remember that diversification is your best defense against the ups and downs of the economy and the markets. Ensuring a well-balanced portfolio will compel you from time to time to sell underperforming investments, to free up your money for better opportunities.

If you have any questions about when to sell an asset, drop me a line: mailbag@investingdaily.com.

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John Persinos is the editorial director of Investing Daily.

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