What Is an Exit Strategy for Investing?

Quick Answer

An exit strategy is a plan for how you’ll liquidate your position and walk away from an investment. Your exit strategy will depend on the type of investment, your risk tolerance and your unique goals and financial health.

Contemplative man researching best exist strategy for investments.

When it comes to investing, an exit strategy is exactly what it sounds like: It's a plan for how you'll liquidate your position and walk away. It's ideal to do this when your investment has increased in value and can provide a profit. Your strategy for getting out will depend on the type of investment, your risk tolerance and your unique goals and financial health.

Having a viable exit strategy is an important part of investing. Getting out at the right time can help maximize your profits and prevent potential losses. Let's explore what exit strategies are in the context of investing—and how to create effective ones.

How Exit Strategies Work for Investors

Exit strategies aren't unique to stock investing. They can benefit investors of all kinds, whether your portfolio consists of stocks, real estate, private equity, cryptocurrency or any other investments that can be bought and sold. Selling an asset for more than you paid for it will result in a profit, but it's virtually impossible to predict which investments will soar (and which will flop). That's why investing is inherently risky. Market volatility, which describes how investment values fluctuate, is part of the journey.

High-risk investments have the potential for the biggest returns but are typically more volatile. The opposite is also true. It can be easy to react emotionally to market swings and sell your investments at a loss. An exit strategy lays out the circumstances under which you'll sell. It can give you something to cling to when the water gets rough. Instead of leading with your emotions, you'll have a logical plan to lean on.

Why Should You Have an Exit Strategy?

An exit strategy can help you get the most out of your investments because it:

  • Clearly defines your investment goals: Investing can have a ripple effect that impacts your overall financial health. The right exit strategy will consider how much you're comfortable spending, what you hope to gain and at what point you'll sell and walk away. This puts your goals front and center so that you aren't investing blindly.
  • Minimizes your losses when selling: Without a clear plan in place, you'll have to decide in the moment whether or not to sell an investment. That can be difficult when emotions are running high. If you're watching the market fluctuate in real time, you might be tempted to cut and run. This could rob you of future earnings if things end up rebounding. An exit strategy provides parameters that allow you to say, "I'll feel OK selling when…"
  • Maximizes your returns: Lots of investors are playing the long game. If you're a few decades away from retirement, for example, you may be comfortable taking on more risk in your investment portfolio because you have more time to recover from market dips. Your exit strategy will reflect that and work to support your long-term goals. This can help maximize investment returns in the long run.

How to Create an Exit Strategy

The first step is clarifying how long you want to keep the investment. Do you plan to buy and hold the investment with the hope that its value will increase over time? Or do you see yourself selling in the short term if the value declines? (Keep in mind that long-term capital gains tax is typically more favorable.) Your risk tolerance and retirement timeline will likely come into play when deciding how long to keep an investment.

At that point, you can create an investment exit strategy. Here are some potential ways to go about it:

  • Profit or loss benchmarks: You may want to sell an investment when it has earned, say, a 15% return. Someone else might only sell if the investment goes down in value by a certain percentage. Selling at that point can stop the bleeding and prevent steeper losses.
  • The 1% rule: This blanket rule advises investors to walk away from an investment if its maximum loss is equal to 1% of their liquid net worth. So, if you have $100,000 in cash savings, that means you should sell an investment after losing $1,000.
  • Stop-loss orders: You can use this type of order to sell a stock when the price reaches a maximum low point. When this "stop price" is reached, it will convert into a market order to sell. A broker will then automatically offload it.
  • Take-profit orders: Think of this as a stop-loss order in reverse. When a stock hits a specified high point, a take-profit order becomes a market order to sell.

The Bottom Line

An exit strategy provides some guardrails for investors by helping them decide when to sell an investment. That might mean securing a profit or cutting losses. The right exit strategy is one that's built around your unique investing goals and financial situation. Investing is risky by design―an exit strategy can help you focus on your objectives without letting emotions cloud your judgment.

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