Selling stock can help cover short-term cash needs but also carries tax implications
Capital gains taxes may apply to any stock sales, depending on how long the shares were held
Investors should establish and build an emergency fund to cover unexpected expenses
If you’re like many investors, you sock money away and invest diligently in a portfolio of stocks and bonds with the intention of building toward your future. But at some point, the future becomes “now.” Perhaps you’ve reached a goal or a milestone, maybe you’re ready to retire and start drawing down assets, or maybe it’s time to plunk down some cash for a big purchase. Those are “expected” cash needs.
On the flip side, you might have an interruption in your income stream right when the furnace decides to quit working. Those are “unexpected” needs.
The life of an investor is full of what-ifs. Here’s a particularly important one to ponder: What if you need to sell some of your stock portfolio? The question could be motivated by any number of factors—some good, some not so good. If this what-if hasn’t crossed your mind lately, it may someday. Are you prepared to answer?
“Any decision to sell or liquidate stock for expected—or unexpected—reasons shouldn’t be taken lightly,” said Michael Fairbourn, an education coach at TD Ameritrade. You may be confronted with a medical emergency, a tuition payment, or some other life event requiring cold, hard cash, right then and there. Here are some things to consider.
“If you do need to sell stock now, do so as judiciously as possible,” Fairbourn said. “Investors should understand potential tax implications and transaction costs, as well as the question of whether selling stock is the right decision for the long term. What may seem to be the right move in the moment may actually not be in the big picture. Proceed carefully.”
Here are a few questions to ponder.
Have You Considered the Tax Implications of Selling Stock?
As Fairbourn pointed out, there are two primary considerations on the tax question. Selling a stock may create a “taxable event,” meaning that depending on how long the stock was held, an investor’s tax liability could be significant. It could also require additional tax obligations down the road.
Capital gains—profits from the sale of an asset such as real estate or shares of stock—are typically considered taxable income. Do you recall the date you bought the stock? In 2019, the U.S. long-term tax rates (for assets held more than one year) are either 0%, 15%, or 20%. Selling a stock that’s already reached the long-term capital gains category could help you reduce your overall taxable income.
In contrast, short-term capital gains tax rates (for assets held less than one year) are generally higher and correspond to an investor’s ordinary income tax rate. (Be sure to know what the IRS considers a capital gain or capital loss and how to report it.)
What About Transaction Costs When Selling Stocks?
Brokerage firms connect buyers with sellers, and historically, they’ve charged commissions or fees for their services: buying and selling stocks and other securities, or other services, on behalf of their customers. A “full-service” broker may once have charged a commission of 1% to 2% of the value of the shares bought or sold, but that’s all changed amid intensifying competition. In October 2019, TD Ameritrade introduced $0 commissions on online U.S. exchange listed stocks and ETFs for all new and existing clients.
How Have Your Stocks Performed, and Why Did You Buy Them in the First Place?
A stock may have disappointed over the short term since you bought it. But if you’re not a day trader think about what it means to be an investor. An underperforming stock could bounce back to generate robust returns in the months and years ahead, Fairbourn pointed out. “If you bail, you could lose on two fronts: the initial loss on the trade, and the potential future return.” However, an upturn in the stock is never guaranteed.
By the same token, watch for any stocks you hold that outdo their peers or the broader market. Is that performance justified in the context of the company’s fundamentals and the overall economy? In other words, do your homework, and think about whether a portfolio component still fits in with your objectives and risk tolerance.
Also, consider any dividend income. Did you buy a dividend-paying stock several years ago, especially at a lower price and for a company that continues to raise its dividend? If you sell, you may be giving up potentially significant income if the company continues to pay dividends. “This so-called cost-to-yield can grow significantly over time,” Fairbourn said. “But really, any future dividend income from this company would be given up when a dividend-paying stock is sold.”
For What Reason Exactly Do You Need the Money?
Some short-term cash needs may be more predictable and easier to plan for than others. Examples include once-a-semester college tuition, an annual property tax bill, or for retirees, a required minimum distribution (RMD). (But the CARES Act, passed in March 2020, eliminated RMDs for the 2020 tax year.)
One idea is to stagger sales of shares based on the overall bill. Sell half the shares a month or two before the due date and the remainder closer to that day, while setting high- and low-price limits on the stock. Although there’s no guarantee the share price will increase between the two sales, the primary rationale here is to establish a disciplined strategy, manage your expectations, and make sure you get the money you need when you need it.
The concept of dollar-cost averaging can work on the way out as well as the way in. And as transaction costs continue to trend downward, dollar-cost averaging has never been more cost-effective.
Plan for tomorrow by setting financial goals today.
What Are the Markets Telling You?
Stock prices go up and down (and sometimes sideways) every day for various reasons, and some price trends last longer than others. If market gyrations on a given trading day make you a little queasy, consider taking a step back and looking at the big picture. Call up a daily chart for one of your stocks and also for a broader market benchmark, such as the S&P 500 Index. Look at the past 12 months or so.
What are the longer-term trends? Is the share price of a specific stock diverging from the broader market? If so, what might be the reasons? Check earnings and economic reports calendars for potentially market-moving events.
Also, you might keep an eye on volatility readings such as the Cboe Volatility Index (VIX) to get a handle on market sentiment. The VIX often briefly spikes higher because of geopolitical flare-ups and other outside events before settling back toward its long-term range.
Often, but not always, those spikes reflect short-term market noise that may not necessarily indicate a need to alter a long-term investment strategy. Still, keep your eyes and ears open for market-related news that may lead to elevated volatility for extended periods.
Do You Have an Emergency Fund That Could Cover Short-Term Cash Needs?
Ideally, investors already have a rainy-day fund covering at least six months’ worth of living expenses in case bad stuff happens—a job loss, for example, said Sam Stovall, chief investment strategist at CFRA. Widespread layoffs and economic recessions (or expectations of a recession) can send stock markets into a nosedive, which is often the worst time to sell stocks, Stovall noted.
As Murphy’s Law tells us: your car will break down, your kid will need braces, and the markets will get spooked, sometimes all at once. Make sure you cover the investing essentials and “expect the unexpected,” Stovall said.
In other words, the best way to avoid needing to choose which of your portfolio components to shed when you need cash is to already have the cash available. Although that may be easier said than done, it’s certainly a goal worth pursuing.