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While selling off investments to pay down credit card debt may seem like a no-brainer, there are some potential consequences to consider first, particularly if you're thinking about using funds you're earmarking for retirement.
Here's what to know about how selling investments to pay down debt can impact your financial plan and other options to pursue instead.
Why You Should Avoid Selling Investments to Pay Credit Card Debt
On the surface, selling off some or all of your investment portfolio to pay off credit card balances might seem like the right move. After all, investment performance is never guaranteed, while paying off a credit card gives you a guaranteed return in the form of interest savings.
But there are good reasons to think twice about dipping into your investment accounts to pay down debt.
Tax Implications
When you sell investments in a taxable brokerage account, you'll need to pay capital gains tax on the gains you've realized in the sale. For positions you've held for less than a year, the tax rate is your ordinary income tax rate, while positions held longer than a year benefit from a lower tax rate.
Even so, the amount you pay in tax will eat into the potential savings you'll get from paying off your credit card balance.
If you're thinking about taking money from a retirement account, you may have to pay income taxes and a 10% penalty on your withdrawal, which combined could neutralize the interest savings entirely.
Lost Future Earnings
While the average annual return in the stock market is lower than the average credit card interest rate, pulling money out of your investment portfolio means that you're missing out not only on future gains on the amount you're selling off but also on the compounding effect on top of those gains.
For example, let's say you have $100,000 in the stock market and are thinking about pulling out $20,000 to pay off a credit card. In 20 years, the remaining $80,000 would be worth roughly $310,000 with an average annual return of 7%.
If you were to keep the full $100,000 invested, though, your money would be worth approximately $387,000 after two decades at the same rate. In other words, you'd end up paying $77,000 in lost gains to pay off $20,000 in debt.
Disruption to Your Portfolio
If you have a well-diversified portfolio, selling off some of your assets to pay off debt could throw off the portfolio's allocations, forcing you to make other trades to rebalance your portfolio. This could result in more capital gains taxes and impact your future earnings.
How to Pay Off Credit Card Debt
While it's tempting to dip into your investments to pay down credit card balances, and it can make sense in certain situations, it's generally best to pursue other options to avoid the negative consequences of selling off investments.
Balance Transfer
If you have good credit, you may be able to get approved for a balance transfer credit card. These cards offer introductory 0% APR promotions, allowing you to pay down a large chunk or even all of your debt without paying another dime in interest.
Depending on the card, promotional APR periods typically range from 12 to 21 months. Just keep in mind that balance transfer cards typically charge an upfront balance transfer fee of 3% to 5% of the transfer amount. But if you can manage to pay off most or all of the balance within the promotional period, that cost is generally worth it for the interest savings.
Personal Loan
If you have good credit, you can also opt for a personal debt consolidation loan. While these loans don't offer a promotional APR, they can give you something a credit card can't: a fixed repayment term.
On average, personal loans have lower interest rates than credit cards, and if your credit is in great shape, you might even qualify for a single-digit interest rate. Note, however, that some lenders charge upfront origination fees, and if your credit is considered fair or poor, you may not qualify for a low enough interest rate to make consolidation worth it.
Debt Snowball or Avalanche Method
Regardless of what your credit score looks like, the debt snowball or avalanche method can be a good way to pay off multiple credit cards.
With the debt snowball method, you'll make the minimum payment on all of your cards and add any extra amount you can put toward your debt to the card with the lowest balance. Once that balance is paid off, you'll take the amount you were putting toward it and add it to your payment on the card with the second-lowest balance. You'll continue this process until you've paid off all of your credit card debt.
The debt avalanche method works similarly to the debt snowball method, but with one key difference: Instead of targeting cards based on their balances, you'll focus on the cards with the highest interest rates first.
The debt avalanche method can help you save more money on interest, but if you want quick wins early on, the debt snowball method may be a better fit.
Borrowing From Family or Friends
While it's not ideal, borrowing money from your loved ones could help you avoid the cost of interest and fees that can come with balance transfer cards and personal loans.
Of course, borrowing money from family members or friends can also have a negative impact on your relationship, so it's important to communicate openly and honestly about your situation and develop an agreement to ensure on-time repayment.
Build Your Credit to Improve Your Debt Options
Whether you're thinking about consolidating high-interest debt or looking forward to future financing needs, building and maintaining a good credit history can help you qualify for lower interest rates, making it easier to save money and work toward your financial goals.
With Experian's free credit monitoring service, you can stay up to date on where you stand, pinpoint where you can make improvements and track your progress.