In an ideal world, you'd never need to sell any portion of your portfolio for cash, but sometimes it's required, for an expected or unexpected reason. Here are some things to consider.
If you’re like many investors, you sock away money, 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, you’re ready to retire and start drawing down assets, or maybe you’re ready to plunk down some cash for a big purchase. Those are “expected” cash needs.
On the flip side, you might have an interruption in an income stream, right when the furnace decides to quit working. Those are “unexpected” needs.
Investors’ lives are 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 one of many 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, Education Coach at TD Ameritrade. You may be confronted with a medical emergency, a tuition payment or other life event requiring cold, hard cash, right then and there. What’s the best course of action?
“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’s a few questions to consider.
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, and also could 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 reached the long-term capital gains category could help you reduce your overall taxable income.
By contrast, short-term capital gains tax rates (for assets held under one year) are generally higher, corresponding 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).
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 in the past may have charged a commission of 1% to 2% of the value of the shares bought or sold, but that’s changed amid ever-intensifying competition. TD Ameritrade, for example, in October 2019 introduced $0 commissions on online stock, option and ETF trades for all new and existing clients.
A stock may have disappointed over the short term since the time you bought it. Still, if you’re not a day-trader flipping stocks like a stir-fry chef at the grill, 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.”
“Often times, what investors give up when they sell the stock amounts to a significant future return,” Fairbourn said. “It’s the ‘investment’ component that makes a stock unique.”
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. “This so-called cost-to-yield can grow significantly over time,” Fairbourn said. “But really, any dividend income would be given up when a dividend-paying stock is sold.”
Some short-term cash needs may be more “predictable” and easier to plan for than others. Examples include once-a-semester college tuition, or an annual property tax bill, or for retirees, the 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, the remainder closer to that day, while setting high- and low-price limits on the stock. The primary rationale: 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.
Stock prices go up and down (and sometimes sideways) every day for various reasons, and some price trends are more long-lasting 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, and 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 due to 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 probably won’t alter a long-term investment strategy. Still, keep eyes and ears open for market-related news that may lead to elevated volatility for extended periods.
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 recession (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 having to choose which of your portfolio components to shed when you need cash is to already have the cash available. While that may be easier said than done, it’s certainly a goal worth pursuing.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
TD Ameritrade and all third parties mentioned are separate and unaffiliated companies, and are not responsible for each other’s policies or services.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 TD Ameritrade.