Selling investments to pay off debt

Here’s a realistic personal finance conundrum: You have stubborn debt that you can’t seem to get rid of, but, separately, funds are sitting and (ideally) growing in your investment accounts. What if you used that investment money to finally dramatically reduce your debt once and for all?

What may seem like a quick fix, however, has significant financial implications to be aware of (hello, capital gains tax). When possible, experts generally suggest avoiding using your investments to pay off debt. However, there is a caveat to this rule: when you have high-interest debt.

Below, Select looks at the pros and cons of selling your investments to pay off debt.

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Selling investments to pay off high interest debt

If you have high-interest debt like unpaid credit card balances, it’s a good idea to take whatever steps you can to take care of that debt, advises Tony Molina, CPA and senior product specialist at the platform. investment robo-advisor Wealthfront.

“Looking at it from an interest rate perspective, if you’re paying 20% ​​interest on credit card debt, you’ll need to make at least 20% on your investments to cover those interest charges,” he said. Molina told Select. “Nobody makes 20% year over year.”

Lynn Dunston, CFP and partner at wealth management firm Moneta Group, agrees that you can quantify the best path to take when deciding whether to pay off debt or stay invested, but her threshold rate is much lower. Dunston provides an “industry common rule of thumb,” explaining that once the debt interest rate is above 4%, it’s harder for your investment gains to overcome the cost of interest.

“At this point, we generally recommend that you pay off your debt,” he says. “Of course, this is only a general rule and specific circumstances should always be taken into account when making important financial decisions.”

A good practice, Dunston adds, is to ask yourself what is the opportunity cost you are giving up by withdrawing money from your wallet to pay off debt. He wants you to think about what your investment money is for so you can weigh what might be compromised if you pay off the debt.

“The money invested will grow,” says Dunston. “If the debt in question has an interest rate of less than 4% and the money invested is earning 8%, you can walk away with the difference by staying invested. You can leave it to grow in an account and return later and use this money to pay reduce the debt.In this scenario, you will come out ahead by keeping the money invested.

Before Selling Your Investments, Consider These Alternatives

Now, while high-interest debt is the caveat here, it’s worth noting that using your investments as payment for that debt can be a final scenario. Sara Kalsman, CFP at robo-advisor Betterment, advises considering suspending contributions to your investments first and prioritizing allocating that cash flow to paying off high-interest debt at a faster pace.

For example, you can use this money to speed up the payment of your credit card debt and combine it with a balance transfer credit card, where your payments can reduce your balance faster because they will not accumulate. additional interest for as long as the 0% APR introductory period lasts. The Citi Simplicity® No Annual Fee Card offers an introductory APR of 0% for 21 months on balance transfers from the date of the first transfer (after that, 16.99% – 26.99% variable; balances must be transferred within four months of opening the account).

Citi Simplicity® Card

  • Awards

  • welcome bonus

  • Annual subscription

  • Introduction AVR

    0% for 21 months on balance transfers; 0% for 12 months on purchases

  • Regular APR

  • Balance Transfer Fee

    5% of each balance transfer; At least $5. Balance transfers must be completed within 4 months of account opening.

  • Foreign transaction fees

  • Credit needed

If you’ve stopped contributing to your investments because you no longer have the money to do so – and therefore have no other funds to redirect to your high-interest debt or credit card balance transfer – there is also a second option to consider before selling your investments. Instead, Molina advises using any available line of credit in your investment portfolio, which essentially means borrowing from your brokerage account. Many major brokerages offer a portfolio line of credit, including Wealthfront, M1 Finance, and Charles Schwab.

“If you sell investments to pay off debt, you will owe capital gains tax, which can be as high as 37% if you hold those investments for less than a year,” says Molina. “Taxes can seriously eat away at your returns.”

By taking out a loan through a portfolio line of credit, you can access your investment money tax-free. Borrowing from your wallet does incur interest, however, but it’s a good option for short-term financing needs (three to six months), such as accelerating the repayment of any high-interest debt.

Finally, whatever you do, avoid dipping into your retirement accounts if you plan to use your investments to pay off your debts. Withdrawals from your 401(k) are subject to regular income tax, and withdrawing early before age 59½ will most likely result in a 10% penalty. “[It] could have a significant impact on your ability to achieve your long-term financial goals,” adds Kalsman.

What about other types of debt?

At the end of the line

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff alone and have not been reviewed, endorsed or otherwise endorsed by any third party.

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