3 Smart Reasons to Sell Stocks in a Bear Market -- and 2 Bad Ones

The S&P 500 is now officially in a bear market, meaning it has dropped more than 20% from its recent high. The Nasdaq and several other benchmark indexes have recently been down by even more.

When stocks fall, especially when it happens quickly like it has over the past couple of weeks, it is only natural to wonder if it's time to sell and move on. For the most part, buy-and-hold investing is the way to go, but there can be some good reasons to sell stocks, even during bear markets.

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Three good reasons to sell when the market plunges

Of course, there are several different reasons why you might want to sell stocks. And selling just because a stock went up or down isn't enough all by itself in most cases.

Having said that, there are some good reasons to sell stocks even in a down market, and most of them fall into one of three categories:

1. Your investment thesis is busted

Perhaps the best reason to sell a stock, regardless of what the overall stock market or economy is doing, is because the reasons you bought the stock no longer apply.

For example, let's say you bought a company because it had a dominant leading market share of its industry, but it suddenly starts losing share to a fast-growing competitor. Or maybe you bought a company for its rock-solid balance sheet and its management team suddenly decides to take on billions in new debt.

Of course, your investment thesis and what could change can vary significantly on a case-by-case basis. But if your investment thesis is busted, it can be a good reason to take your capital and move on to other opportunities.

2. You need the money

One of the most obvious reasons to sell stocks is that you need the money. Ideally, you'll plan for financial needs several years ahead of time, and I've often said that any money you'll need within the next few years shouldn't be in the stock market, and the recent market turbulence is a perfect example of why.

However, it isn't always possible to anticipate financial needs, especially in unfortunate circumstances situations such as job loss or inflationary environments.

3. You need to rebalance

According to the often-used Rule of 110 for asset allocation, subtracting your age from 110 tells you the percentage of your portfolio that should be in stocks, with the rest in fixed-income instruments. So, if you're 40, this implies that you should maintain a 70% stock and 30% fixed income portfolio.

Now consider this simplified scenario. Let's say that you have $70,000 in stocks and $30,000 in fixed income. Due to a market crash, your stocks fall by 25% but the value of your fixed-income investments stays roughly the same. Now you have $52,500 in stocks and $30,000 in bonds, which is a 64% stock and 36% bond mix. In order to bring your asset allocation in line with your target, it can be a good idea to sell some fixed income investments (like bond ETFs) and roll that capital into stocks.

One bad reason to sell

In a bear market, avoiding the bad reasons to sell stocks can be even more important than using the good reasons.

Specifically, selling stocks just because the price went down, whether we're in a bear market or not, isn't a good reason to sell all by itself.

To be clear, if the price went down because the company is losing market share, management is taking on too much risk, or any other reason that changes your investment thesis, it could be a good time to sell.

But the point is that the classic panic-selling logic of "I'd better get out before things get any worse" is a good way to lock in poor investment performance and miss out on the eventual rebound of the market. After all, investors who panicked and sold during the 2008-09 financial crisis missed out on the start of one of the greatest bull markets of all time. In short, good companies should be held for as long as they remain good companies or if you have a legitimate reason to sell and move on.

A silver lining (but not a great reason to sell)

Many people mistakenly believe that selling just for the tax benefits -- a move known as tax-loss harvesting -- is a good reason to sell stocks in a down market.

You can use any investment losses to offset any capital gains you have for the year. In other words, if you sold a stock at a $5,000 gain in January and you sell a stock at a $4,000 loss in this bear market, it would effectively reduce your capital gain to $1,000 for tax purposes. Even if you don't have capital gains to report, up to $3,000 of losses can be used to lower your taxable income.

However, it's important to think of tax-loss harvesting as a silver lining of selling stock at a loss -- not as the initial reason for selling. In other words, don't sell beaten-down stocks just for the tax benefits if your investment thesis remains intact and you don't have any other good reason to sell.

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