With Inflation Lingering, Is It a Good Idea to Sell Your Stock?

Americans continue to face the challenge of high living expenses, with everyday necessities such as groceries and gasoline maintaining elevated prices despite efforts by the Federal Reserve to curb inflation. Despite the Fed's two-year campaign to lower inflation rates from 9% to 3%, its strategy has faltered in recent months, with inflation climbing back up to 3.5%. As consumer prices erode purchasing power, some individuals are finding themselves compelled to tap into their investment portfolios and retirement accounts for temporary financial relief.

While it may go against common belief, there are instances where lightening one's portfolio or dipping into retirement savings may be appropriate. However, such occasions are rare, and withdrawing from investments means sacrificing potential future growth for immediate financial relief, necessitating careful consideration.

Here's what you should know if you're ever considering selling your stock.

How to Sell Stock in a Brokerage Account

Investors open brokerage accounts for various reasons, whether to supplement retirement savings beyond the limits of a 401(k) or IRA or to explore the stock market and earn extra income. Regardless of the motive, investors may find themselves needing to sell stocks and ETFs to cover living expenses. In such cases, what's the best approach?

While selling off well-performing stocks and ETFs may seem prudent, it's not always the case. Instead, when in need of quick funds, it's advisable to first consider selling off underperforming investments.

This might appear counterintuitive since these investments have incurred losses. However, according to Dr. Bob Johnson, a finance professor at Creighton University, this mindset is a logical fallacy. "As humans, we tend to hold onto our wins and fear our losses," he explains. "People often hold onto a losing stock, hoping it will bounce back to break-even, delaying the realization of losses. This behavior, termed 'get even-itis,' can be costly."

Johnson suggests that it's actually more advantageous to sell off losing investments than winners due to the tax implications. If you realize more losses than gains in a tax year, you can offset up to $3,000 in losses against ordinary income, avoiding a capital gains tax of up to 37% on profitable stocks. This strategy not only provides liquidity without incurring significant taxes but also allows investors to restructure their portfolios, shedding weak investments while gaining valuable experience in refining their investment strategies.

Regarding the timing of selling losing equities, it's advisable to prioritize selling fundamentally weak positions with considerable unrealized losses over stronger but currently underperforming investments. Conversely, if your portfolio primarily consists of winning investments, it's prudent to sell off losing positions before realizing gains, thus minimizing tax liabilities.

Early Withdrawal and Borrowing from a 401(k)

It's crucial to exercise caution when considering tapping into retirement savings. According to Johnson, raiding a 401(k) should be a last resort due to the associated penalties and long-term consequences. Early withdrawals from a 401(k) incur a 10% penalty on top of ordinary income tax, limiting future financial flexibility and potentially forcing individuals to work longer or live below their desired standard of living.

While it's possible to withdraw funds from a 401(k), it's generally preferable to explore alternative options to mitigate penalties and preserve retirement savings. One such option is borrowing against the 401(k), which allows individuals to access funds without incurring penalties or sacrificing equity. Since it's a loan from oneself, there's no credit check required, and the process is typically faster and carries lower interest rates than traditional loans.

Although borrowing from a 401(k) offers immediate financial relief, borrowers must continue making regular contributions to their accounts to avoid derailing their retirement savings plans. While it may provide a short-term solution, it's essential to weigh the long-term implications and explore other avenues before resorting to tapping into retirement funds.