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Selling Index Funds

When should you sell your index funds?

At about the same time you should turn down free money.


If the market is going up about 8% a year, you're making money...so you want to stay in. If you really want to sell, think about why you want out and other alternatives you can take.

The Costs of Selling

You may want to cash in your index funds so that you can buy something like a used Honda. You have $25,000 in index funds and you need $10,000 for that rust bucket that's going to get you to and from class every day.

One problem: You're going to have to take out more like $12,000 to pay for the car. Why? If you bought the funds 8 years ago and have been doing well with them, you might have gains of $6,000. That makes the taxman's eyes light up because you'll have to pay, say, 30% for long term gains taxes to the federal and state tax offices.

So that's about $1,800 on top of any transaction fees you get charged for selling your funds.

What About Borrowing?

You have another option: you can borrow $10,000 from yourself, using your assets (that's your index funds) to secure the loan. Companies like Schwab have margin services that let you borrow from yourself; it's cheaper than the financing you'd get at the dealership, but it's not free money.

You're going to have to pay it back, and if your fund drops too low, you're going to be what is called 50% margined (that's money guy talk for "you stepped in it good"). At that point, the brokerage will usually insist on what is known as a forced sell. And that's exactly what it sounds like: you're going to have to sell your shares, like it or not, at the current market prices (which will be brutal, since that's what caused the problem in the first place).

And remember: when you decide to play with your investments either by cashing them in or by borrowing against them, you're hurting your chances of making more money. If you're selling your funds for that Honda, you've lost out on the chance to make money off that cash—and now you've got car repairs, gas, and other expenses taking a big bite out of your budget. If you're borrowing against your investment, you have to pay it all back (with interest).

Either way, you've got less money to put towards your investments.

Sometimes, of course, you might not have a choice. If those funds the only thing between you and bankruptcy, your options are limited. But in an ideal world, you'll hold onto your funds for as long as possible. The Honda will be waiting for you on the other end…and by then, it might be a Ferrari.

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