Should I Sell Investments or Tap My Emergency Fund?

Stuck with an unplanned expense? Here's how to decide how to cover it.

You never know when an unplanned bill might land in your lap, whether it's a car repair, a home repair, or a hospital invoice. It's important to maintain a solid emergency fund so you’re always ready.

As a general rule, you should aim to have three to six months' worth of living expenses on hand in your savings account. Not only might that money help you tackle an unexpected bill, but it could help tide you over during a period of unemployment.

But your emergency fund may not be your only source of money if an unplanned bill comes your way. If you hold investments in a traditional brokerage account (as opposed to a retirement plan, like an IRA), you're allowed to cash out those investments at any time without penalty. If a need for money arises, you may be torn between tapping your savings account versus liquidating some stocks.

For the most part, you're generally better off raiding your emergency fund in that situation than cashing out investments. But there can be some exceptions.

The problem with liquidating investments

The upside of keeping cash in the bank is you don't have to worry about losing out on any portion of your principal deposit until you take a withdrawal. With an investment account, the value of your balance can fluctuate based on the performance of the market.

The issue with selling investments to access cash is that you risk locking in losses by selling them when they're down. And that's one reason why tapping your emergency fund is generally preferable when a need for money arises.

Say there's a company you own 10 shares of that you bought for $200 apiece. If, at the time you need money, those shares are only worth $190 apiece, cashing out will mean losing $100 (whereas if you leave those shares alone, their value might easily come back up in a week or so).

But even if you're looking at selling investments at a profit to access cash, doing so isn't always ideal because it will trigger capital gains taxes. The amount of taxes you'll be charged for selling investments at a profit will hinge on how long you held them for prior to selling. But going back to our example, if the 10 shares you bought at $200 apiece are now worth $210 apiece, that's a $100 gain. And if you cash out, you'll be taxed on that $100.

By comparison, when you take withdrawals from a savings account, you don't get taxed at all. You're not making money in a savings account other than collecting interest. And while bank account interest is taxable, removing money from your savings won't add to your tax burden. If anything, it should lower it by virtue of leaving you with less money to earn interest.

What's the right call?

If you're sitting on long-term capital gains in your brokerage account (which apply to investments held for at least a year and a day), and you're a lower earner, capital gains taxes may not apply to you. In that case, if you'd rather cash out investments than tap your emergency savings, go for it. Though, be aware that liquidating investments means losing out on the chance to have them gain more value.

But if you have a healthy level of emergency savings and investments in a brokerage account, you're generally better off withdrawing from the former when a need for money pops up. Even though long-term capital gains taxes max out at 20% for high earners, and most people are subject to a 15% tax rate on them, it's silly to pay taxes at all when you can raid your emergency fund instead.

Besides, the whole point of having an emergency fund is to cover unplanned bills. You might as well use that money for its intended purpose so you can let your investments grow.