The inevitable ups and downs in the stock market leave many investors wondering, "Is it time to cash in?" Unfortunately, there is no formula for deciding when to call it quits. Ask 10 different analysts and you are likely to get 10 different answers, each backed by reasonable logic. Each investor has a unique portfolio and personal circumstances; therefore, each investor should consider the following before determining if it is time to cash in. (For more, see To Sell Or Not To Sell.)
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Consider Your Goals
How committed are you to your investments? What are your goals? A person who takes big risks and is gunning for large, fast rewards may not want to sit around while the market is tanking. Alternatively, a person whose goal is to grow money slowly (and who has the time and the patience to do so) may be more apt to wait for the market to turn around. No investor likes to lose money, and while the market fluctuations and corresponding emotional roller coasters are challenging, these tough spots do not warrant walking away from the stock market altogether. Prior to making any decisions, each person's goals and risk tolerance should be examined.
Younger investors with years of wage earning ahead of them can usually afford to risk more money. As such, these investors might be better able to weather a tumultuous period in the stock market. A 30-year old, for example, likely has at least another 30 years of investment activity before any earnings would be counted on for retirement income. Because the time horizon for buy and hold investing could be decades, it may not make sense to cash it all in because of a bad year or two.
Those closer to retirement, or already in retirement, must be more cautious when it comes to investing. While it might be reasonable for younger investors to wait for a position to rebound, retirees may need to consider closing underperforming positions in exchange for more conservative stocks or bonds. The time available between now and when the investor plans to use the money - whether that is one year or 20 years - must be taken into consideration.
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An investment portfolio is hardly an all-or-nothing venture. Underperforming investments can be eliminated, new investments can be entered, and the portfolio, while rearranged, remains intact. The weighting of different investment vehicles can be changed as well. For instance, if stocks are performing poorly, these positions can be lightened and the money can be used to purchase low or lower-risk instruments, such as Treasuries or even Certificates of Deposit (CDs). Of course, these low risk investments do not offer the opportunity for significant earning potential, but they can provide a safety net for unsure investors who are waiting for more certain market conditions. (To learn more, see our Certificate of Deposit Tutorial.)
Capital Gains Tax
Selling most investments for a profit will result in a capital gains tax. So while your investment may not be doing as well as it was last year, if you sell if for more than you paid for it (or for more than it was worth when you inherited it) you will likely owe a capital gains tax. The tax treatment is generally more favorable on long-term capital gains than on short-term capital gains. To qualify for a long-term capital gains tax rate, the stock must be held for at least one year. Tax implications should be considered prior to closing out investments and careful attention should be paid to the duration of the investment. (To learn more, see Capital Gains Tax 101.)
Pay Down Debt
If an investor does decide to cash in, rather than redistribute, a portfolio, any money can be used to pay down debt. The money that is saved by avoiding additional interest fees can be viewed as earnings. If your debt load is so high that you would save a significant amount of money in interest payments, you might consider using some of the money you have set aside for investments to pay down the debt. This may be particularly true if your debt load is high and investment earnings are low. Paying down debt now will give you more money for future investing, which could result in larger overall savings.
The Bottom Line
Unfortunately, there is no one-size-fits-all answer to this question. It really depends on an individual's situation. Many considerations must be made, including your investment horizon, tax implications, personal debt load and retirement goals. Professionals, including Chartered Financial Analysts (CFA) and Certified Financial Planners (CFP), can help individuals and families make decisions on investments, debt and retirement planning. Since investing is, for most people, a long-term endeavor, decisions should be made carefully and rationally, and not as an emotional response to challenging circumstances. (For more, see Portfolio Management Pays Off In A Tough Market.)
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