Many people depend on their investments not only for long-term gains but also as a steady source of cash. But when stock prices plunge—as they did in August—selling off shares of stock to meet expenses starts to decimate your holdings at an alarming rate. I know ­investors who panicked during the August market plunge and dumped their riskiest holdings to raise cash. In doing so, they locked in steep losses so they could feel momentarily safer—but probably damaged their long-term portfolio returns unnecessarily.

Here is the four-step strategy I recommend for investors who find themselves forced to sell something right away…

1. Clean up your past mistakes. Most people own one or more investments that they probably should never have bought and that don’t fit in with their goals…risk tolerance…and/or time horizon. This may include not only ­investments that may be too aggressive for you, such as gold, which can be very volatile…but also ones that may be too conservative, such as money-market funds. Determine which investments don’t really fit in with your overall needs and sell those first.

2. Rebalance your long-term allocations. Sell from the portion of your portfolio that has grown large enough that it has exceeded your allocation targets. For more on determining stock and bond allocations, go to SEC.gov.

3. Determine whether each investment you currently own would be attractive to buy today. Too often, investors focus on whether an investment has had a big loss or a big gain since they bought it, rather than whether it’s likely to do well in the future. If you wouldn’t buy one of your current investments at its current value, that’s a strong signal that it is a candidate for selling if you need cash.

4. Consider tax consequences last.  Taxes should never be the dominant factor in choosing investments to sell, but they should not be ignored either. Consider how big a capital gain or capital loss would be generated by the sale of an investment in a taxable account. And consider whether it makes most sense to tap into a taxable account…a tax-deferred account such as a traditional IRA or 401(k)…or a Roth IRA or Roth 401(k), whose withdrawals are tax-free.

Keep in mind that selling stocks in a taxable account could mean paying ­taxes on capital gains at a rate that may be lower than your income tax rate, unless you have held the investment for just a year or less. Withdrawals from a traditional IRA or 401(k) are taxed at your ordinary income tax rate. And if you are younger than 59½, the IRS may charge you a 10% penalty for withdrawals from traditional and Roth IRAs unless you qualify for one of the exceptions that apply. Penalties also may apply for withdrawals from a 401(k).

For more details on tax ­consequences, go to IRS.gov and search for Publication 590-B for IRAs or 560 for 401(k)s.

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