This week let’s look at a question I’ve received from a number of clients recently. The question has several variations but revolves around a central theme: What do we sell to generate cash when stocks are down?
This question isn’t about trying to time markets or reacting to media-driven uncertainty and fear. Instead, it’s a practical one where folks are trying to fund their living expenses in retirement, or perhaps they have larger expenses coming up and will soon be in need of cash.
As we all know, stocks plunged mid-February through April, but an upsurge has followed. Some stocks have recovered half (or more) of their losses, so thinking about selling and taking a breather from risk can seem obvious. But while this might make good intuitive sense it’s probably a bad idea for the long term.
We never want to be forced to do anything and it’s no different when it comes to investing. I’d much rather have options and asset allocation (your preferred mix of stocks, bonds, and cash) provides some good ones at times like these. While the stocks in your portfolio have been taking a hit lately, your bonds have likely been performing well, even for the last year or more. This provides a good opportunity to do something counterintuitive: not selling stocks when they’re down – selling bonds instead.
The typical core bond fund is up around 4% this year and perhaps 10% over the past 12 months. There are several reasons for this, but the bottom line is that if you’re looking for cash to spend from your portfolio, bonds are probably best to sell first. Longer-term bonds have been up the most, followed by medium-term and then short-term. You can pick from these funds in that order to help meet your spending needs. An exception to this would be high-yield, or “junk bonds”. This category tends to behave like stocks during volatile times and have done poorly lately. These would be the last bonds to sell.
If you’re retired, hopefully you have at least a few years’ worth of spending needs stored in bonds. But assuming you end up spending all your bond money, then you might be forced to sell stocks before a full recovery. If you’re finding yourself in this situation now, as with deciding which bonds to sell, there’s a priority to consider.
Small-cap stocks have performed the worst in recent months, followed by mid-caps. This is mostly due to these smaller publicly traded companies being local (domestic, not large multinationals) and investors assuming these businesses would be hit hardest by national lockdown orders, cratering consumer demand, and so forth. Large-cap stocks (the multinationals) have fared the best lately, with the Large Cap Growth category being the best performer by far.
So, which category of stocks do you think you’d pull cash from first? You might look at small-caps and want to unload those because they’ve done poorly, but it’s likely better to sell large-cap funds first, especially the growth-oriented funds. This latter category has many of the big healthcare and tech names that have been able to weather this storm best. They’re the cleanest dirty shirt, so to speak, in your stock portfolio and would be the best to sell first should there be a need.
If you’re selling bonds and stocks in your retirement account, you don’t need to worry about capital gains taxes. But if you’re selling in your non-retirement, or brokerage account, then capital gains taxes are a consideration. Assuming you “harvested” losses during the past couple months, you can use those losses to offset any gains from selling bonds. If you haven’t yet harvested, maybe now is a good time.
Additionally, you may notice that aggressively selling bonds and then picking off your stock funds also upsets your asset allocation. If you started out with 60% of your portfolio in stocks and the rest in bonds and cash, you could find yourself getting ever closer to having 100% of what’s left invested in stocks. While that’s not something you’d necessarily sign up for initially, it’s sometimes what you need to do if you’re living off your money and stocks are down for a prolonged period (which is certainly possible moving forward from here).
The idea with this more practical take on asset allocation would be to let yourself get off track with your preferred allocation but then rebalance back to normal when markets have stabilized. Since we’d hopefully only be pulling money from your bonds, we’d be able to leave your stocks alone and let them fully recover, even if it takes multiple years. This is absolutely preferable to feeling forced to sell stocks when they’re down. Doing do, as we all know, locks in your losses and makes it much more difficult to recover from a market downturn.
Have questions? Ask me. I can help.
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