No one likes to sell when the market is down, but sometimes you don’t have a choice—maybe you have to pay a tax or medical bill in the immediate future, or you’re retired and need to replenish your cash reserves. So how can you make the best of a bad situation?
“The important thing is to think strategically, and not just liquidate assets as part of a mad rush to the exits,” says Mark Riepe, head of the Schwab Center for Financial Research. “Selling when the market is dropping can mean locking in losses, and .”
“So if you absolutely have to sell something, do it in a way that doesn’t undermine your ability to meet your investing goals, and take the opportunity to improve the quality of your portfolio,” he says.
With that in mind, how should cash-strapped investors proceed?
- Rebalance. Periodically selling overweight positions and buying underweight ones to keep your portfolio in line with your chosen asset allocation and risk level is a good practice in the best of times, but it can also help you be methodical if you need to generate cash when times are tough. Imagine you’re an investor with a moderate tolerance for risk and a target allocation that is 60% stocks, 35% bonds and 5% cash investments. Let’s further imagine that even after a short-term pullback, a long bull market has left your stock allocation at 80% of your portfolio. Selling some of your stock holdings to bring you back to your 60% target allocation can help you generate cash to pay your bills, as well as give you funds to invest in your underweighted asset classes.
- Take out the garbage. Rebalancing gives you an opportunity to revisit all of your holdings to see if they still deserve a place in your portfolio. Think of it as a line-item veto, and if you wouldn’t consider investing more in a particular security today, then you should seriously consider selling it. Don’t be sentimental: How a stock performed in the past doesn’t matter if it’s unlikely to deliver in the future. If a once-promising stock has started to underperform its peers or the broader market, then check out the underlying company’s earnings and balance sheet for signs of weakness. Schwab clients can use Schwab Equity Ratings to get a sense of a stock’s prospects by logging into and entering its ticker symbol. Mutual fund investors can also see how their holdings compare by entering a fund’s ticker symbol and clicking the "Performance" tab.
To be clear, actions like these should be a regular part of your investing strategy. But what if you’re at your target allocation and all your securities are of reasonably high quality?
- Harvest losses. Do you have an investment that’s got an unrealized loss and is held in a taxable account? Consider selling it to raise cash now and then using the loss to offset any investment gains you may have realized—a strategy known as tax-loss harvesting. And if you haven’t realized any gains, you can still use those losses to offset up to $3,000 of your ordinary income per year until all your losses have been used up. Just be sure you don’t violate the by repurchasing the same or “substantially identical” securities within 30 days before or after the sale, lest your losses be disallowed.
- If you have to sell for a gain, be tax smart about it. If you still need to sell assets, focus on those you’ve held for more than a year to take advantage of lower long-term capital gains tax rates. Gains on stocks, bonds, and mutual funds held for over one year are currently taxed at a maximum federal long-term capital gains rate of 20%. Investments you’ve held for one year or less will be taxed at your federal income tax rate.
Selling when the market is down can be painful. However, it can also serve as an opportunity to revisit your plans—or to create a plan if you don’t already have one. Your first line of defense against market volatility should be a portfolio that is appropriately allocated based on your goals and investing timeline.
Portfolios for people near or in retirement should include a mix of investments to fund spending now (money for the next year), soon (the next two to four years), and later (four years and beyond). These portfolios should contain an appropriate combination of higher- and lower-risk investments.
- For the short term, consider investing in historically less-volatile investments, such as cash investments and short-term bonds. Having a year’s worth of expenses in cash, plus a short-term reserve, can really help in the event of a downturn—if you have the resources to wait out the volatility or bear market, and not sell more volatile investments, you’ll be better off.
- For the intermediate term, a diversified portfolio including cash investments, bonds, and some stocks can help to balance your risk and return potential. The closer you are to your goal, reduce your risk accordingly.
- For the longer term, where you have the capacity to weather a few down days, or even a bear market, you can invest more aggressively.
“Investors with a reserve react a lot differently than those who get blindsided and have never laid that groundwork,” Mark says.
“It’s not just about your risk tolerance--which is your ability to emotionally handle big price swings and losses,” he adds. “It’s about your financial capacity to handle risk. In other words, can you afford to take a loss?”
What You Can Do Next
- Want to talk about your portfolio? Call Schwab at 800-355-2162, visit a branch or find a consultant.
- Learn more about at Schwab.
- If you need a plan for your retirement income, consider Schwab Intelligent Income™, an automated investing tool available with Schwab Intelligent Portfolios® that can help you generate tax-smart withdrawals each month.