The stock market’s recent coronavirus jitters demonstrate that if you’re going to sell, it’s best to follow a plan.
Many investors didn’t do that. The volatility caught a lot of people by surprise, helping to explain why the stampede toward the exits became so intense.
Selling stocks, mutual funds and other investments shouldn’t be done as a knee-jerk reaction. Rather, it’s something you should ponder well before the need arises. There are many tax and other factors that you should carefully consider first.
Ponder your reason for selling
You might have to sell at least some of your stock-market holdings because you need the cash. Perhaps you have a tax bill or large medical expense looming or need to raise cash for a down payment.
But sometimes you might feel pressure to sell simply because you’re uncomfortable with paper losses — or because you assume everyone else is selling. It’s nerve wracking watching prices slide on a down day, but all those red numbers don’t necessarily mean you should take any actions.
“You don’t really have a loss until you sell,” said Ed Slott, a certified public accountant and retirement-plan expert. “Often the worst thing to do is sell out of fear.”
Mark Riepe, head of the Schwab Center for Financial Research, said it’s important to think strategically. “Selling when the market is dropping can mean locking in losses, and permanently undermining a portfolio’s ability to recover,” he wrote in a recent blog.
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Evaluate the tax impact
If you’re selling mutual funds or other assets within a 401(k) plan, an Individual Retirement Account or another tax-sheltered vehicle, your sell decisions likely won’t have any bearing on your tax situation. But in unsheltered brokerage accounts, there can be all sorts of repercussions.
The obvious one is that you could incur a tax bill — and possibly much sooner than necessary. If you don’t hold your investments at least one year and a day, your gain will be short-term and you will face taxes at ordinary income rates rather than at lower capital-gain rates.
“Check the holding period first, to be sure,” said Matthew Kenigsberg, a Fidelity vice president for investment and tax solutions.
Beware a Medicare surprise
When you lock in gains by selling, it can do more than just add to your taxable income. You also might lose eligibility for certain benefits like retirement accounts, lose deductions or push some of your Social Security payments into the taxable category.
“It starts a ripple or domino effect,” said Slott.
For example, Medicare participants who realize too much income can face several hundred dollars annually in premium surcharges if enrolled in Part B (covering doctor visits) or Part B (prescription drugs). Medicare bases these surcharges on taxable-income amounts from two years prior, so a gain realized this year will affect premiums in 2022.
“The surprise will come in two years,” Slott said.
These surcharges are called Income Related Monthly Adjustment Amounts or IRMMAs and can be researched at medicare.gov. They’re just one example of the secondary tax effects that can be triggered by selling investments at a gain.
Look to harvest losses
Conversely, one potential tax benefit to selling is that you might be able to lock in capital losses that can be used to shelter investment gains and, possibly, regular income.
This is what tax-loss harvesting is all about. By locking in losses, you can use them to offset realized capital gains from your portfolio. If there are excess losses, you can utilize them to offset up to $3,000 in ordinary income each year, with the ability to carry forward unused amounts.
Harvesting a tax loss can be a worthwhile move for investors who feel the need to take some type of action during a market selloff, Kenigsberg said. “Think of a tax loss as an asset,” he said. Selling to lock in a loss can “give people something constructive to do” when emotions are rising high because of market volatility.
Harvesting losses also can provide an opportunity to upgrade your mix of investments. Consider it an “opportunity to revisit all of your holdings to see if they still deserve a place in your portfolio,” Riepe suggests.
Consider rebalancing instead
The idea of taking profits in certain stocks that have fared well over time — and then reinvesting the proceeds in laggards — is the concept behind rebalancing.
There’s no set answer as to when or how much you should rebalance. Some people do it once a year while others do it after their asset allocation or target portfolio mix has gotten out of whack — shifts of perhaps 5% or more. Regardless, rebalancing provides a discipline for selling (and buying other things) periodically, helping to remove emotions from the process.
Rebalancing tends to work better with asset classes or groupings — small value stocks, European stocks, long-term municipal bonds or whatever — rather than individual securities. That’s because individual companies can falter and never rebound, but distressed asset classes will tend to recover over time.
Inquire about other restrictions
For the most part, buying and selling stocks, mutual funds, exchange-traded funds and all sorts of other common investments is easier, faster and cheaper than ever. But occasionally, you might face impediments that can frustrate your sell objectives — or make things more costly.
For example, some mutual funds have back-end loads or sales charges that you could trigger. Various redemption fees also might apply.
In addition, some employees might face restrictions on when they can sell their company’s stock, whether inside or outside of 401(k) retirement plans, said Kenigsberg.
“In many cases, all sorts of restrictions might apply,” Kenigsberg said. Inquire about these possibilities before making a move.
Reach Wiles at email@example.com or 602-444-8616.