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

***Money is not a client of any investment adviser featured on this page. The information provided on this page is for educational purposes only and is not intended as investment advice. Money does not offer advisory services.***

Americans continue to be beleaguered by the high cost of living, with prices of everyday items like groceries and gasoline remaining elevated despite the Federal Reserve’s attempts to rein in inflation. The Fed’s two-year campaign to cool inflation brought rates down to 3% from 9%, yet in the last six months, its strategy has worn thin and inflation has ticked back up to 3.5%. As consumer prices continue to erode purchasing power, some people now find themselves in a position where they are forced to tap into their investment portfolios and retirement accounts in order to find temporary financial relief.

Contrary to popular belief, there are cases in which it might be appropriate to lighten your portfolio or even dip into your retirement savings. However, these are rare events, and withdrawing from your investments means missing out on future growth potential in exchange for a short monetary reprieve, so the decision to do so shouldn’t be taken lightly.

Here’s what you need to know if you ever plan to sell your stock.

How to sell stock in a brokerage account

Investors open brokerage accounts for many reasons. For some, it’s to supplement retirement savings without facing the contribution limits of a 401(k) or an IRA. For others, it’s to earn some money on the side and learn the ins and outs of the market. Regardless of why investors open brokerage accounts, they may need to sell their stocks and ETFs to help offset living expenses. If so, what’s the best way to go about it?

While grabbing gains from stocks and ETFs that’ve performed well since being purchased might seem like the fiscally responsible move, that’s not necessarily the case. On the contrary, if you need to come up with money quickly, consider dumping the losers in your portfolio first.

That might seem counterintuitive; after all, you’ve lost money on those investments. But Dr. Bob Johnson, professor of finance at Creighton University, explains that this idea is a logical fallacy. “As humans, we save our wins and dread losses,” he says. “People will have a losing stock in their portfolio and they say, ‘Well, I’ll sell it as soon as it gets back to where I bought it,’ because they rationalize that they haven’t really lost anything until they sell it. I call that ‘get even-itis.’”

According to Johnson, it’s more costly to fall for this “get even-itis” and sell off winners than it is to dump the underperformers. “The tax code is set up so that you should actually sell your losers over your winners,” he says.

If you need to cash out some positions, the tax code makes selling losers a better choice: If you realize more losses than gains in a tax year, you can use up to $3,000 in losses to offset your ordinary income, as opposed to paying a capital gains tax of up to 37% on proceeds from a winning stock, depending on how long you’ve held the investment. You can even use further losses to offset gains you want to realize on your winners later on.

Not only does this strategy allow a cash-strapped investor the chance to get some liquidity without paying capital gains tax, but it also allows you to reorient your portfolio; you can drop fundamentally weak investments with little harm done and you’ll walk away more knowledgeable when it comes to finding a strategy that works for you. Quoting famous mutual fund manager Peter Lynch, Johnson says that “selling winners and holding on to losers is like cutting the flowers and watering the weeds.”

As for timing the sale of losing equities, it depends on how many you own relative to how much money you need. If you have considerable unrealized losses in positions that are fundamentally weak, getting rid of them before fundamentally strong positions that happen to be in the red is a good idea. But if your portfolio is lined with winners, you’ll probably want to close your losing positions before taking a tax hit on the winners.

Early withdrawal and borrowing from a 401(k)

Let’s be clear: By and large, you don’t want to mess with your nest egg. “There’s two reasons not to raid your 401(k) and try basically everything else first,” says Johnson. The first of these, he explains, is that you have to pay a penalty when you take money out. In addition to the ordinary income tax on money pulled from a tax-deferred account, you’ll also assume a 10% early distribution penalty on 401(k) investments if you’re under 59.5 years old.

Secondly, and perhaps more importantly, Johnson says that taking money from a 401(k) early leaves you with fewer options later in life as you scramble to make up for those early withdrawals. “Your options are you work longer or you live at a lower standard of living — neither of which are good alternatives,” he says. Think of raiding your 401(k) as borrowing from your future financial comfort: Accessing funds now means less later.

That being said, it is plenty possible to pull funds from a 401(k), but since it’s a tax-deferred account, you won’t get the benefits of realizing losses like you would by selling stock in a brokerage account. An alternative option, which allows you to dip into your 401(k) with less penalty than selling off the account’s assets, is borrowing against it.

401(k) loans allow cash-strapped investors to access money from their retirement accounts without suffering the penalties or loss of equity that comes with early withdrawal. Even better, since you are borrowing from yourself, there’s no credit check required, obtaining the loan is much quicker than securing a traditional one and interest rates are typically lower than those offered by traditional lenders. Ultimately, you’re paying yourself back and on friendlier terms.

In most cases, borrowers have up to five years to satisfy the loan, affording you plenty of time to recover from whatever precarious financial situation forced you to borrow against your retirement savings. The main drawback is that when borrowing from a 401(k), you must also make your regular contributions to your account, lest you fall off track.

If you find yourself strapped for cash due to escalating living costs, selling portions of your investments isn’t ideal, but it is feasible. Depending on the type of account you hold assets in and how much liquidity you need access to, you may be able to lighten your portfolio or borrow from your accounts in a way that minimizes financial damage while providing the money you need to get out of a pinch.

More from Money:

5 Best Stock Trading Apps of 2024

These Major Retailers Are Cutting Prices to Lure Inflation-Weary Buyers Back

Eyeing Bigger Gains, Investors Shift from Consumer Staples to Cyclical Stocks

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