Tapping into savings to pay off debt can be a wise choice. Getting out of debt doesn't just save money by reducing the interest you pay. It also increases your flexibility because less of your paycheck has to go to pay off money you've already spent. This can, in the long run, free up more money for savings. However, selling mutual funds specifically to pay off debt may not be the best way to do it.
Comparing Interest Rates
Generally, if you are paying more to borrow money than you earn on money you have saved, you're better off cashing in your savings to pay off your debt. For example, if you have $5,000 in credit card debt at 17 percent per year, you're paying $850 in interest. Selling off $5,000 in mutual funds that yield 9 percent per year would only cost you $450 in annual income, putting you $400 per year ahead.
Mutual Fund Problem
Selling mutual funds presents two challenges. First, because they should be relatively good performers for you, you get less benefit from selling them than from cashing in other investments. In the above example, you save a net of $400 a year. If you could pull the $5000 out of a savings account paying 0.50 percent per year instead, it would save you a net of $825 per year. The second is that it can cost money to sell your mutual funds. Even if you don't have a sales charge or commission, you may have to pay tax on any profits you receive when you sell. This reduces the amount of money you can use to reduce your debt.
Before selling mutual funds, look for other investments you can use to pay off debt. The greater the gap between your debt's interest rate and the interest rate of the asset you're using to pay off the debt, the more you're saving. If you can also sell off assets without paying taxes, you come out even further ahead. While it's wise to have an emergency fund, if you keep your credit lines open after you've paid them off, you may even choose to make do with a smaller emergency fund than you otherwise would have.
Retirement Account Funds
When you hold your mutual funds in a retirement account like a 401(k), individual retirement account or Roth IRA, the balance may shift. First, pulling money out of those funds can be expensive because you will probably have to pay a 10 percent penalty along with regular income taxes on everything you pull out -- or on all of your profits from a Roth IRA. Second, money in retirement accounts may be sheltered from your creditors if you ever have to file bankruptcy.
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