Investing

3 questions to ask yourself before selling an investment

Twenty/20

Much of the advice about investing focuses on getting started in the stock market. However, the day will inevitably come when you need to sell your investments.

Just as you should have a long-term strategy for investing in the stock market, you'll need to develop a plan for determining when to sell — and then stick with it. Otherwise, you risk succumbing to a common cognitive bias of withdrawing money from the market at the worst possible time.

"If you're prepared in advance, nothing should be a surprise," says Tim McGrath, a certified financial planner and managing partner at Riverpoint Wealth Management. "A lot of people don't have a game plan or process for determining what to sell."

It's important to consider the long-term consequences associated with a short-term decision. If you sell investments because of a bout of turbulence, you could miss out when the market eventually rebounds, as it always has in the past. Alternatively, treating your investment account like an ATM could create an unexpected tax burden.

Before you sell an investment, experts recommend asking yourself thee following questions.

1. Why do you want to sell?

Your reasons for wanting to sell an investment could range from practical to emotional, and it's important to understand what's motivating your decision. A good way of sussing that out is by asking yourself if selling the investment will fund a want or a need, says Mike Kojonen, a financial advisor and founder of Principal Preservation Services.

"Don't use your investments for something you just want to buy," he recommends. That's because you'll pay a price for doing so, including capital gains taxes on profits.

Oftentimes, Kojonen's clients will reconsider selling investments once they understand the implications of doing so — and particularly if it was to fund a short-term "want," like a car or a vacation, he says.

To avoid surprises that might cause you to sell an investment to cover an emergency, McGrath says it's important to plan ahead. That means anticipating major expenses you might have in the next 12 to 24 months and ensuring you have an emergency fund that can cover at least three months worth of living expenses.

If you’re prepared in advance, nothing should be a surprise.
Tim McGrath
a certified financial planner and managing partner at Riverpoint Wealth Management

Even so, emergencies do arise that might warrant selling. That said, you will want to have a plan for which investments in your portfolio you'll sell — and why.

Finally, check your emotions. Both Kojonen and McGrath try to determine if the real reason one of their clients wants to sell is motivated by fear. If you're frustrated with your portfolio's performance or worried that a market decline is coming, remember why you invested in the first place and make tweaks rather than overhauls to your strategy.

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2. Do you understand what selling will cost?

You may look at the value of your investment and think you'll get to keep all of that. But Uncle Sam will want a cut, as well.

Before you consider selling, you'll want to make sure you understand the associated costs, which could include:

  • Transaction costs. Does your broker or robo-advisor charge a fee for liquidating some or all of your account?
  • Capital gains taxes. How long have you owned this investment? If it's been less than a year, you'll have to pay short-term capital gains taxes on the profit, which is the equivalent of ordinary income tax. If it's been longer than a year, your tax obligations are lower.
  • Penalty for early withdrawals. Are you considering taking out money from a 401(k) or an IRA? You should avoid dipping into your retirement account, because that money can be taxed as income. And if the money isn't for a qualified exception, you'll have to pay a 10% penalty.
  • Opportunity cost. Every dollar you remove from the market is a dollar less that's earning interest for retirement or other long-term goals. To see the power of compounding, consider the following example from Fidelity: If you leave a retirement account of $6,000 untouched instead of cashing out when you switch jobs, in 35 years that could grow to more than $64,000 — even without any other contributions in the interim.

Once you understand all of these costs, you may have a change of heart. That said, there are good reasons to sell investments, including rebalancing your portfolio to maintain your chosen mix of various stocks and bonds and taking advantage of investing strategies that can lower your tax bill.

3. What happens next?

Even if you decide that selling an investment is your best option, you need to have a plan for what happens next. That includes a strategy for when you'll actually sell, a budget for the costs outlined above, a decision about where that money goes after you've liquidated it, and a plan for reinvesting that money again later.

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And you'll want to be sure you walk through all those steps first, because you may realize there's a better place to get money from rather than selling an investment, Kojonen says. "The key is having a plan in place."

Finally, if the desire to sell an investment is spurred by nervousness about bumpiness in the market or your financial situation, it may be time to revisit your investment strategy.

Check-in on your upcoming expenses and goals at least once a year to make sure you're prepared for any changes ahead, McGrath recommends. That's because you should have at least a five-year time horizon for any money that's invested in the stock market, he adds.

"Investments can be a terrible place to put money if you need it too soon or markets aren't where you need them to be when you need the money," McGrath says.

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