How to Protect Investments During Cash Emergencies

When a financial emergency arises, many people worry about how they can pay for unexpected expenses, and in the heat of the moment, panic can often lead them to cash in on their assets. This attitude can end up being very costly for those who have invested in assets such as stocks, shares, and bonds, and can result in significant losses in addition to immediate financial hardship.

Yes, there are many reasons why you should not withdraw from your investments in case of an urgent need for cash. Although it might seem the easiest solution to your problems, in the long run, it will cause a lot of damage to your finances.

Instead of tearing into your portfolio, your focus will be on relieving pressure on your finances so you can set up your portfolio for success again in the future. We take a grounded approach to ensuring you can address current financial shortfalls without crippling long-term investment returns and associated tax implications along the way.

Understanding the Real Costs of Selling Assets Early

When you have an urgent expense, you may want to liquidate your stocks or funds to access the money you already have in your investment. And in some respects, that money is yours, and it’s right there in your account. But in reality, there are a lot of hidden penalties that could actually cost you more than the amount of money that you withdraw from your investments.

The biggest risk to your portfolio during a market decline is selling stocks. We have all heard of the statement that “paper losses are not real losses.” What that means is that a decline in the value of your investments is not really a loss until you actually sell the investment. When we are in an emergency situation, however, we tend to forget that statement and immediately sell our stocks in a declining market. This forces us to lock in the decline in the value of our investments for all time. We will miss out on any subsequent recovery in the market, and as a result, the earnings on our portfolio will be permanently reduced.

Taxes present another massive hurdle.

It can also trigger a number of negative investment consequences, such as low current returns on investment or even capital losses if you sell before the investment recovers. In addition, early withdrawal of investments held in taxable investment accounts could result in the investor being forced to pay significant capital gains tax, and there also could be negative tax implications on any realized investment losses. As stated above, withdrawal of pre-retirement contributions to tax-advantaged retirement accounts in most cases would result in very negative consequences as well.

Building an Accessible Reserve as Your Main Defense

Finally, the best form of protection for your long-term wealth is an emergency fund. In a nutshell, an emergency fund is a pool of cash that you have set aside for just such a circumstance. In the simplest case, it is held in a savings account. You can earn a return on your cash by investing it in a money market fund, which will provide you with returns, but it will also lock up your cash. It’s generally better to hold cash in liquid savings accounts, which provide ready access to your funds. You can consider the money in your emergency fund “untouchable.”

It is generally wise to keep three to six months of essential living expenses in liquid form (i.e., ready access). This amount can vary depending on a variety of factors, including the volatility of your income. You should keep this amount of cash completely separate from your primary checking account and from your long-term investments (e.g., stocks, mutual funds, retirement accounts). Liquid cash for emergencies should be invested in a variety of liquid, low-return investments (e.g., high-yield savings accounts, money market accounts and notes).

Having liquid funds to draw upon will give you some breathing space before you need to consider selling some of your investments. In the end, of course, you will need to draw upon your investments, but you will have had some time to consider the implications of selling your investments before you have to do so.

Smart Alternatives for Short-Term Cash Needs

Are there other alternatives before liquidating your portfolio?

High-priority situations where an urgent expense exceeds the capacity of your liquid savings can be managed through other non-investment funding options that can also solve your financial emergency in the shortest period of time.

In situations where very fast liquidity is required, short-term financing can serve as an effective bridge to protect your portfolio. Obtaining access to fast capital through solutions offering same day funding allows you to resolve urgent financial obligations right away while keeping your core investment portfolio intact and growing over time.

Personal lines of credit, flexible repayments on existing loans, and even a temporary change to the interest rate on an existing loan could provide the necessary breathing space. Importantly, though, the cost of any borrowing must be compared with the potential long-term losses to investment returns as well as tax implications. In many cases, the cost of borrowing will be less than the potential losses from selling long-term investments early.

In many cases, a well-managed debt can be even cheaper than selling off your long-term growth assets in order to raise cash to meet a financial crisis. And of course, the biggest part of dealing with a financial crisis is keeping your hands off your long-term wealth and allowing it to continue to grow over time.

Strategic Portfolio Adjustments and Safe Liquidation Order

Stress can drive investors to make rash financial decisions, perhaps worse than none at all, by liquidating investments to satisfy short-term cash needs, including greater-than-average tax burdens. Moreover, investors will sometimes wreak havoc on their portfolio’s asset allocation, potentially causing greater long-term wealth impairment than existed initially. A reasonable approach would be to liquidate funds in the best possible tax structure first. Then sell assets to “rebalance” or to “harvest” investment losses to offset any ensuing capital gains from an investor’s other sold assets. Under no circumstances, though, should one ever withdraw capital from tax-advantaged retirement accounts.

You can use money in your Cash and Cash Equivalent investments as well as in your Short Term Fixed Income investments in your Taxable Investment Accounts. These investments tend to have little to no downside risk, meaning that they typically do not decrease in value and therefore can be used to liquidate some of your investments.

Next, when required, rebalance your taxable investment assets to required percentages, cashing in over-investment positions while restoring your desired capital allocation and lowering your resulting tax liabilities to the extent of corresponding capital gains.

Retirement accounts should stay at the absolute bottom of your list.

Withdrawals from a retirement account are too costly!

Establishing a Proactive Habit of Risk Management

This type of scenario needs to be planned in advance in order to be dealt with in the best possible manner. Planning for a financial shock in advance means planning a strategy to deal with a financial crisis in the best possible manner. In the meantime, having sufficient liquidity will suffice for dealing with any financial surprises that might occur. This is why it is advisable to review your liquidity needs regularly, such as annually, to update your financial reserve needs and other financial obligations in accordance with changes in your life, income, and expenses.

So how do you make this sustainable over time?

These investments can also be deposited on an ongoing basis. In addition, it is also very important to have the right ratio of liquid cash to defensive investments and growth investments as your total amount of money increases. This will prevent you from becoming ‘asset-rich but cash poor’.

A good shield is not only about investing in good assets, but also about creating a good system around them. A good system is one that can weather unexpected storms and still achieve your financial goals. By having a good amount of cash in reserve, sensible short-term financing options in place, and a good liquidation strategy, you will be able to deal with any unexpected event that may arise and still be able to achieve your long-term financial goals.