Being in debt can be damaging in many ways. Debt can lead to additional expenses from interest charges and a decrease in credit score. Plus, it can limit your ability to finance new purchases. If you find yourself in a situation like this, you might be trying to get out of debt as soon as possible however you can.
One option could be to sell profitable investments to cover your debt, like selling stocks that have gained value and using the proceeds to pay off loans or credit card bills. However, according to some experts, not all debt is bad, and selling profitable investments to pay off debt can sometimes backfire. Some debt can even be considered a net positive, such as how a low interest rate mortgage could enable you to grow your net worth through real estate price appreciation.
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To determine whether you should sell profitable investments to pay off debt, consider the following factors.
Also see five myths about debt that nobody should believe in 2024.
Investment Returns vs. Interest on Debt
A simple way to look at this issue is comparing what you’re earning from your investments with what your debt is costing you.
“From a dollar-and-cents perspective, compare the return you expect to earn on your investments with the interest rate on the debt you are considering paying off. If the interest rate of your debt is higher, there is an opportunity,” said Olivia Johnson, founder of Oz Optimizer, a financial and spend planning app geared toward Gen Z and millennials. “However, it is important to factor in the tax consequences.”
When selling profitable investments, you could face capital gains taxes. Some interest on debt is also tax-deductible. For example, student loan interest is deductible up to $2,500. So you’ll have to also weigh how taxes will ultimately affect your investments and debt.
On the flip side, sometimes your investment returns outpace debt interest rates, meaning you’re making money by keeping your investments.
“For example, I work with a client who has $500,000 in assets and a $90,000 consumer loan at 10%. Their investment portfolio has averaged a 12% return over the past five years. In this case, paying off the debt early would likely reduce their overall net worth. However, by using their assets to generate income, such as constructing a bond portfolio to cover loan payments, they can effectively manage the debt while their investments continue to grow, providing a sense of reassurance,” said Ryan Graves, CFA, president of Bemiston Asset Management.
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Your Debt Burden
Sometimes you’re better off paying your debt off over time rather than hurting your cash flow or hampering future potential investment gains by selling assets to quickly pay off debt. If you don’t have a heavy debt burden, like if you’re simply paying off a small car loan on a monthly basis, then rushing to pay off debt might not make sense.
“Selling stocks to pay your debt could be a big mistake if your debt burden is manageable. Manageable means the income from your job and portfolio can cover your obligations, eventually paying off your debt. Any advice prioritizing accelerated debt repayment over the past decade has been costly,” Graves said.
But it can be a different story entirely if your debt has become unmanageable. “However, if we’re talking about high-interest credit card debt — 20% or more — selling assets to pay it off makes sense. You can’t out-earn such high rates; carrying that debt will erode your wealth over time,” he said.
One way to make your debt burden more manageable could also be to use investment gains, like dividends or fixed income interest payments, to go toward paying off debt.
“If you can service your debt using your income and avoid selling growth assets, you should do it. If necessary, you can structure your investment portfolio with more income-producing bonds to help service the debt and avoid selling and withdrawing from your investment portfolio,” Graves said.
Your Goals
Lastly, consider your overall goals. “Whether to sell investments to pay off debt depends on your financial goals. If your primary goal is to increase net worth, paying off debt too early can be counterproductive, especially if your investments earn a higher return than the debt interest rate,” Graves said.
For some people, being in debt is really uncomfortable. Even if it’s not the most rational choice, it’s possible that you could be better off selling investments to become debt-free from a life satisfaction standpoint. But it’s also important to consider longer-term financial goals, like retirement. Focusing too much on debt might cause you to underinvest in your retirement.
“We sometimes see in our users the assumption that all debt is created equal and should be paid off as a top priority. An example where this may not be the case, however, is paying more than the minimum payment on your student loans — of course depending on their interest rate — if it means not contributing enough money to retirement to get your full employer match,” Johnson said.
Lastly, think about what assets make sense — or don’t make sense — to sell, depending on your goals.
“In general, avoid selling assets like your home or withdrawing retirement funds. If necessary, sell from your brokerage account or explore loans against your assets, such as a HELOC or a 401(k) loan, to cover high-interest debt without liquidating your core investments. You would need to check the terms of these options, but they are usually pretty decent and would effectively allow you to pay off any high-interest debt and maintain your growth assets,” Graves said.
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This article originally appeared on GOBankingRates.com: Should You Sell Profitable Investments To Pay Off Debt? Experts Explain