Stocks are a valuable part of any portfolio, and for many, they're a safety net in lean times. When your liquid savings are running low, relying on your shares can help you cover emergency expenses and avoid greater consequences. Keep in mind, however, that there are always trade-offs when you sell any investment, and cashing out stock means exposing yourself to:
- Brokerage fees: Your broker charges a commission when you sell stock. It could be as much as 1% to 2% of the withdrawn asset if you use a full-service broker. Discount brokers charge much less, typically $5 to $10 per trade.
- Taxes: If you've held your shares for two years or more, your withdrawals are taxed at a long-term capital gain of 15%. If you sell your shares before then, your earnings are taxed as ordinary income based on your tax bracket.
- Lost growth potential: Perhaps the biggest risk in selling stock is the loss of potential growth. Pulling your money out of the market means sacrificing future earnings if your investments move in the right direction. For example, I bought 500 shares of Shopify back in April when it was trading at about $76 a share. As of September 15, the stock is valued around $120 a share, and selling before today would have meant sacrificing a $22,000 profit and paying ordinary income taxes. Consider the X factor of loss and do your homework regarding your stocks' earning potential.
Still ready to cash out your investments? Here are a few situations where selling stock might be the necessary choice.
1. Your budget has changed
A major life change can throw you off balance, and it's important to recalibrate your finances without taking on unnecessary debt. For example, suppose you have a baby and your company doesn't cover maternity or paternity leave. Unless you have enough in liquid savings, you'll need to find another source of income to sustain you for a few months, and credit cards aren't the answer. If you need some temporary breathing room, selling stock could provide much-needed security.
2. You have credit card debt
Cashing out long-term investments to satisfy short-term debt shouldn't be your first choice, but it might be wise if your credit card balances are out of control. For instance, suppose you need $5,000 to cover living expenses for the next two months. At 18% interest, you'll pay $125 for more than five years and accrue nearly $2,700 in interest along the way. On the other hand, selling $5,000 in long-held stock means paying a 15% capital gains tax, or $750, and usually a brokerage fee. Credit card debt can kill your budget, damage your credit score, and prevent you from saving well in the future. If you're looking for a fresh start, stock earnings could help you wipe the slate clean.
3. You want to avoid loans
Personal loans are useful when you don't have the cash for big-ticket items, but they can also come at a bad time. For example, 55% of parents take on more than $40,000 in loans to put their kids through college, according to a Discover Student Loans survey, and most can't afford to carry new debt as they near retirement.
In this case, suppose a 55 year-old father borrows $45,000 to fund his daughter's education. At 7% interest with a 4.3% loan fee, the federal Parent Plus Loan would take him 25 years of $333 monthly payments to satisfy, and he'll pay nearly $55,000 in interest over the life of the loan. Cashing out investments from his employee stock purchase plan (ESPP) will allow him to avoid doubling the loan principal with accrued interest, placing a strain on his budget, and increasing his debt-to-income ratio. He'll also have 10 years to make up the difference without the burden debt. Consider the drawbacks of relying on a loan rather than stock earnings. The fine print might lead you to sacrifice some of your investments.
4. You're trying to earn a bigger profit elsewhere
Selling stock in favor of a larger payoff is a smart move, especially if the rewards are immediate. For example, suppose you need to sell your Seattle home right away, and you also need to gain a profit. The latest data says that a few minor improvements can significantly increase your property value, but you don't have the savings to contribute. Rather than taking on a five-year loan with a 4.5% interest rate, funneling stock earnings into the project can help you make the changes you need without taking on additional debt. A hot real estate market also means that your home will sell quickly, allowing you to reinvest in stock right away.
It's tough to part with established investments, but the benefits outweigh the risks in certain situations. Do the math and examine your options carefully in an emergency. How you manage today's problems is sure to affect your future.
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