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UNSCHEDULED//Life Happens: How Investors Can Plan for Expected (or Unexpected) Cash Needs

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.

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5 min read
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Key Takeaways

  • 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 a rainy-day, emergency fund to cover unexpected expenses

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. Perhaps you have a large purchase coming up, or a big college expense. And let’s not forget, if you’re 70 ½ or older, you might need to take a required minimum distribution (RMD) from your tax-deferred retirement accounts. 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 with 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.

Have You Considered the Tax Implications of Selling Stock?

There are two primary considerations on the tax question, Fairbourn said. 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,” Fairbourn said, 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, Fairbourn said.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).

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 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.

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 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 said. 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, Fairbourn said. 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,” he said.

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, or an annual property tax bill, or for retirees, the aforementioned RMD.  

One idea is to stagger sales of the 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.

What are the Markets Telling You?

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.

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 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.

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Key Takeaways

  • 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 a rainy-day, emergency fund to cover unexpected expenses

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