In this clip from “Financial Planning Q&A 60” on Motley Fool Live, recorded on Jan. 26, Motley Fool contributor Dan Caplinger discusses how and why to create a cash cushion and the factors that investors should weigh when going about generating one.
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Dan Caplinger: A couple things here. One is, what you sell in order to generate a cash cushion depends on a bunch of factors. The tax issues that you suggested are one of them. I think probably more important from a long-term investing standpoint is what your conviction is about what each of those stocks is likely to do in the future whether you believe those companies are going to rebound, whether those stocks are going to climb over the long run, regardless what their past performance has been. If that is one of the guiding factors, then that’s something to take into account. The other thing to think about, Mike, is that you talk about, does it make sense to take an IRA distribution in order to get the cash cushion? My gut instinct immediately is, if you have the cash already in your IRA and you’re just talking about, do you have to distribute it out of the IRA in order to meet your cash cushion? My gut answer is no, you do not have to take it out. It can be part of your cash cushion even if it’s still in the IRA. Keep in mind, you’re hoping not to have to use the cash cushion. You’ll look to replenish the cash cushion on a regular basis once stocks are behaving more normally. The purpose of the cash cushion is just to be there in the event that you have a really major downturn. In that case, that’s the only situation which you would need to take stuff out. If you have the cash in the IRA, don’t worry about moving it out right away. As long as it’s cash somewhere and you have access to it, then it can count as part of your available cash. As far as the rest of it, tax-loss harvesting, there are benefits to doing that. You don’t want to sell a stock that you think is going to perform extremely well going forward, regardless of whether it has performed extremely well in the immediate past, or whether it’s gone down in value and you think that it’s going to rebound.
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