Is It Smart to Liquidate Your Investments?

When the stock market is crashing, liquidating may not be the best tactic.

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Sometimes you need to liquidate your investments because you need the money for something you want to purchase. At other times, you might be tempted to liquidate your investments because you fear a market drop or your stocks are not performing as you had hoped. An impulsive decision to liquidate has transaction cost, tax and total return consequences, so consider carefully your reasons for liquidating before entering sell orders.

When You Need the Money

Investments are a way to put your savings to work earning more money for a big-ticket purchase or for retirement. If you only need part of the total value of your investment, selling everything could have serious tax consequences. Short-term capital gains are taxed at a higher rate than long-term capital gains, so first consider selling your longer-term holdings if you need only part of the money. Capital gains taxation rules change frequently, so consult a tax professional before you sell.

When Your Stocks Are Not Performing

If your stocks have not performed as you had expected, it might be time to review earnings reports, analyst reports and stock price charts for each investment type. Rather than liquidating everything, first diagnose the financial health of your individual holdings and consider whether they are solid long-term investments or are likely to continue to underperform the market. Weeding out the poor performers and reinvesting in better prospects is a valid portfolio management exercise and is often preferable to a sudden and complete withdrawal.

If You Think the Market Will Drop

If you are concerned that the market is about to correct or drop significantly, consider using trading techniques to protect your investments. These involve placing stop-limit orders or hedging with options. Unless you have used these techniques successfully in the past and understand their limitations, check first with an investment professional before placing your trade orders.

If the Market Crashes

As you watch the market drop, you might panic and give in to the understandable temptation to sell everything, thinking of it as a way to cut your losses. Before you shoot yourself in the foot, consider a lesson from history: Market crashes are sometimes deep, but they've always been temporary, and people who took advantage of severe downturns by purchasing top quality stocks at rock bottom prices have made good profits when the market roared back. People who sell during a crash, by contrast, can lose a significant portion of their investment and pay high taxes on the money they withdrew. If you have invested in highly rated stocks, the underlying companies are likely to continue to make good earnings and regain their financial strength. Your best choice may be to do nothing and wait out the downturn or add to your best positions.