Should I Sell Off Investments to Pay Down My Debt?

Debt can be costly -- but should you liquidate potentially profitable investments in an attempt to get rid of it?Image source: Getty Images.

Being in debt is problematic for a number of reasons. For starters, the longer you carry it, the more money you end up throwing away on interest charges. Not to mention that in some cases, holding on to unhealthy debt could wreck your credit score, making it more expensive for you to borrow again when you need to.

If you’re loaded with debt but don’t have the cash on hand to pay it off in a reasonably quick fashion, you may be inclined to tap your investment portfolio, sell off some investments, and use the proceeds to cover your obligations. Whether or not that’s a good idea, however, will depend on your circumstances.

The cost of debt vs. investment gains

To see if it makes sense to sell off investments to pay your debts, you’ll need to compare the cost of your debt with the amount of interest you stand to forgo by selling off an investment. For example, say you're carrying a balance on a credit card that charges 18% interest. If a given investment of yours generally delivers an average yearly 6% return, you may be better off liquidating that asset and using the proceeds from its sale to pay down your debt, since you'll come out ahead financially by doing so.

That said, chances are you have different assets in your portfolio that generate different returns. When deciding which to sell off, you should opt for the ones that deliver the lowest returns. For example, if you have a bunch of stocks that have collectively given you a 12% average annual return in recent years, and some bonds that have yielded just 3% on average, it makes sense to hang on to the stocks and cash out the bonds, assuming you won't lose money in the process.

And that, of course, leads to another important point: If you're going to sell investments to pay off debt, aim to avoid taking losses on them. While investment losses can help lower your taxes, that's not what you're trying to do here. Rather, you're trying to scrounge up as much money as possible to chip away at whatever debt you're saddled with. So if you have an investment you stand to lose money on by selling it right away, it pays to hold on to it and see if it recovers. At that point you could liquidate it and use your proceeds to address your debt.

Of course, the type of debt you’re carrying should also be part of the equation. If you’re carrying healthy, low-interest debt, such as a mortgage, then you shouldn’t rush to sell off investments to get rid of those obligations. On the other hand, if you’re talking about costly, unhealthy debt, like that of the credit card variety, it may be wise to sell off some investments and use the proceeds to lower your balance.

Don’t forget capital gains taxes

The money you make from selling investments at a higher price than you paid for them isn’t all yours to keep. Any time you take in capital gains, the IRS is entitled to a piece of your profits.

Capital gains come in two varieties: short-term and long-term. Short-term capital gains apply to investments held for a year or less, while long-term gains apply to investments held for at least a year and a day. You’ll pay a lot less tax on long-term capital gains than you will on short-term gains, so if you’re considering selling off investments to pay down debt, aim to liquidate those assets that fall into the long-term gains category.

Will using investments to eliminate debt help you avoid that mistake in the future?

In some cases, it is a good idea to sell off investments to pay down debt, but before you do, think about why you landed in debt in the first place, and aim to not have a repeat. Remember, you can’t always count on being able to liquidate assets to tackle debt. The stock market could tank, for example, and until it comes back up, you might have to leave your investments alone. So don’t count on your portfolio to bail you out, because the point of having one should be to invest for the long haul, not pay down pesky credit card balances. Adopt smart financial habits so you’re not stuck in an unhealthy debt scenario again. At the same time, build some emergency savings so that the next time an unplanned bill lands in your lap, you won’t be forced to rack up debt in the course of addressing it.