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You’ve probably heard that the path to financial success involves paying off all your debt, saving at least 10% of your money, cutting spending, building an emergency fund and maximizing your retirement plan contributions. But the reality is that most Americans live on a limited budget, even paycheck-to-paycheck, and it can be hard if not impossible to accomplish all of these financial tasks.
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If you have stocks, for example, it can be hard to know if you should stick with your investment plan or liquidate what you own to pay off your debt. Here are some of the factors you should consider so that you make the right moves on your path to financial independence.
Generally speaking, you want to try to avoid selling stocks to pay off debt. But in some cases, simple mathematics pushes the needle in that direction. For example, if you have a lot of debt but it’s at a 0% interest rate, there’s really no hurry to get it paid off. It’s not costing you anything extra in interest — although it might affect your credit score — and selling off stocks can cost you future growth.
However, the situation might be reversed if you have outstanding credit card debt, which can carry interest rates north of 20%. Since the long-term average return of the stock market is about 10%, it makes mathematical sense to give up potential returns of 10% for the certainty of eliminating a 20% debt. However, there are additional factors to consider in this equation beyond the straight mathematics.
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In the financial markets, there are always consequences to taking action. If you sell your stocks, not only are you giving up potential future gains, you’ll also have to consider your tax liability.
If you sell a stock one year or less since you bought it, any gains will be taxed at short-term gain rates, which are the same as your ordinary income tax rate. If you’re a high earner, that might push your rate as high as 37%. You may also owe state capital gains taxes. In that case, the $10,000 in stocks you sell might only translate to $6,300 that you could use to pay off your debt. It’s a good idea to sit with a tax or financial advisor to help you figure out all the tax ramifications of selling your stock.
One option to consider when it comes to your tax situation is to sell off your losing stocks and use them to offset your capital gains. This way, not only will you avoid paying taxes on your sale, you’ll actually be able to avoid taxes on a comparable amount of gains that you have. You can even use $3,000 per year in losses to offset your ordinary income.
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