Should You Sell Investments at a Loss to Pay Off Debt?

Selling investments to pay off debt

First, it’s worth acknowledging the risk of putting money you might need in the short term into stocks or stock-based ETFs. That’s not a criticism of you, Ruth, but a useful reminder for others: equities can be volatile, and when you need liquidity in the near term, market downturns can create difficult trade-offs.

Historically, broad stock indexes like the S&P 500 have produced positive annual returns roughly three-quarters of the time over long periods. That means a reasonable chance of a positive return year-to-year, but also a meaningful chance of a loss in any given year. Diversification—owning a broad mix of holdings rather than a few individual stocks—reduces the chance of experiencing severe losses.

It’s also important to remember that “safer” assets such as bond funds can lose value, especially when interest rates rise. For example, bond funds that track broad bond indexes declined in recent years when rates moved higher, because bond prices fall as yields rise. That dynamic can make choosing between selling investments or carrying debt more complicated.

How well do your investments need to perform?

Let’s focus on the practical question: what should you do now? Your ETFs are down and you’re carrying a home equity line of credit balance with interest near the current prime-related rate. If your HELOC rate is around 7.45% to 7.95% (prime plus a margin), you need to weigh the after-tax return your ETFs must earn to justify staying invested rather than selling to pay off the debt.

Because investment returns are taxed, an ETF that generates, say, a 10% return will likely have some portion taxed as dividends or interest, reducing your net return. If 2%–4% of that 10% is taxable income, after tax your effective return might fall by roughly 1%–2%. That means your portfolio would need to outperform the HELOC interest rate by that margin just to break even financially. In other words, a gross return of around 10% might be required to cover a near-8% borrowing cost once taxes are considered—an outcome that is possible but not guaranteed.

Interest rates can move, too. If your HELOC rate rises, the required investment return to come out ahead increases; if rates fall, the threshold drops. Given this uncertainty, the decision often comes down to your comfort with risk and the amount of stress you feel holding the current arrangement.

When should you consider selling?

A common but unhelpful approach is to fixate on getting back to the original purchase price before selling. That mindset can trap investors into holding losing positions longer than they should. Instead, view the decision from the perspective of whether you’d buy the same ETFs today with cash if you had it. If the answer is yes, staying invested may make sense. If the answer is no, selling might be the better option.

If you sell to raise cash and pay down the HELOC, the immediate benefit is eliminating the monthly interest drain and the ongoing stress of carrying that debt. Selling costs at most a small brokerage commission if you use a discount platform, and you should also consider how long it might take for the ETFs to recover. Recovery could take months or several years, depending on market conditions and the types of funds you own.

Another factor is your time horizon for needing the money again. If you expect to withdraw most or all of these funds within five years, holding volatile assets increases the risk you might be forced to sell at an unfavorable time. For money needed sooner rather than later, shifting to less volatile holdings or paying down high-interest debt is often the more prudent move.

Watch for tax deductions and superficial losses

There is a tax strategy to consider: if you sell the ETFs, pay off the HELOC and then borrow again specifically to invest, the interest on that borrowings may become tax deductible because the loan proceeds were used for investment purposes. That deduction can meaningfully reduce the after-tax cost of carrying the debt.

However, be careful about superficial loss rules. If you sell an ETF at a loss and repurchase the identical ETF within 30 days, tax rules generally prevent you from claiming that capital loss—the sale becomes a superficial loss. If you want to realize and use a capital loss this year, avoid repurchasing the same fund within the 30-day window. One workaround is selling the ETF and buying a similar fund that tracks the same index from a different provider, which preserves market exposure while avoiding a superficial loss.

Capital losses can only be used against capital gains. If you have no gains this year or in the prior three years to offset, realizing a loss may not provide immediate tax relief unless you carry it forward to future gains.

In short, there’s no single right answer. If you’re comfortable waiting and the cost of borrowing is reasonable relative to expected returns, staying invested may work. If the monthly interest payments are causing stress or you doubt the portfolio will achieve the necessary after-tax returns, selling to pay down the HELOC and reducing debt may be the smarter, lower-risk choice. Consider your time horizon, your tolerance for volatility, and consult a tax advisor about the implications of any sale and possible tax planning moves.

Read more from Jason Heath:

• How much to take out of your RRSP in your 60s
• What can I hold in an FHSA?
• How to use income ETFs for retirement income
• Is now the time for retirees to sell stocks and buy GICs?
• Should you accelerate your mortgage payments—or invest?