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Say I have a portfolio composed of 80% index funds, and 20% bonds. This portfolio was created under the assumption I would have a relatively large income, and wouldn't need to withdraw any funds for a few years.

Now, some time after this portfolio was created, this assumption is proved incorrect. I am now earning less than I used to, and actually need some extra cash, so I plan to cash in on a part of the portfolio.

My initial instinct tells me I should withdraw bonds, because "stocks and index funds are best held over a long period of time, while bonds can be withdrawn more readily". However, when I analyse the situation I actually reach the opposite conclusion - if my 80%/20% portfolio was drafted on the false assumption that I would earn X, and I now earn Y, I need to shape the portfolio to be less stock intensive, perhaps 60%/40%. In order to do that, the best thing right now would be to sell off index funds and not bonds.

The painful thing is that my index funds actually lost a good deal of money in the last year, and ideally I would want to hold them for a bit longer to let them "regain value" - but I do have to keep in mind that the stock market is "memoryless" - past performance has very little or no implication on future performance - so my plan right now is to indeed sell index funds and not bonds.

Is my analysis correct?

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The answer may be a compromise... if your goal is to make bonds a larger part of your portfolio, sell both stocks and bonds in a 4:1 ratio. or (3:1 or whatever works for you)

Also, just as you dollar-cost-average purchases of securities, you can do the same thing on the way out. Plan your sales and spread them over a period of time, especially if you have mutual funds.

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Don't set mental anchor points. I am saying this as a total hypocrite, mind you, it isn't easy to follow that advice.

My suggestion would be to look at each investment and ask yourself, "Would I buy that at today's price?", because if you wouldn't you need to sell regardless of whether you are cashing out.

Effectively by staying in an investment you no longer believe in, you are giving up the opportunity cost of investing that money in something with a real chance to give you a return, or in your case whatever purpose you have in mind for the cash.

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    +1 Modulo transaction costs, this is always the right answer.
    – jprete
    Commented Nov 1, 2011 at 14:20
  • The "Would I buy at today's price" question may not be completely applicable to the index fund investor. The index fund investor generally just has faith in the overall market and doesn't think they can beat it buy evaluating individual stocks. Your answer is not bad advice, but I don't think it's applicable to the question.
    – Mike Piche
    Commented Nov 15, 2011 at 0:34
  • I'd argue it still applies. If you wouldn't buy into that index fund (for whatever reason) in the present then you probably should investigate other options.
    – JohnFx ♦
    Commented Nov 15, 2011 at 0:39
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So I don't have any problems with your analysis or the comments associated with it. I just wanted to mention that no one is talking about taxes.

Your answer....Figure out new portfolio breakdown and sell to 1.) Get money I need and 2.) re-balance the portfolio to my new target allocations is completely correct. (Unimpeachable in my opinion.)

However, when you calculate what you need to sell to meet your current cash needs make sure to include in that analysis money to pay taxes on anything you sell for a gain, or keep some invested to account for the tax money you would save by selling things for a loss. The actual mechanics of calculating what these amounts are are fairly involved but not difficult to understand. (IE every situation is different.)

Best of luck to you, and I hope your cashflow gets back up to its previous level soon.

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You are right about the stock and index funds, with dollar cost averaging over several years, the daily price of the security (especially a dividend paying security) will not matter* because your position will have accumulated larger over several entry points, some entries with cheaper shares and some entries with more expensive shares. In the future your position will be so large that any uptick will net you large gains on your original equity.

*not matter being a reference to even extreme forms of volatility. But if you had all your equity in a poor company and tanked, never to rise again, then you would still be in a losing position even with dollar cost averaging.

If your only other holdings are bonds, then you MAY want to sell those to free up capital.

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    -1 Dollar cost averaging was not even mentioned in the question. I don't understand why you've centered your answer on it.
    – jprete
    Commented Nov 1, 2011 at 14:23
  • jprete, it should be obvious if you know what dollar cost averaging is. The only reason that stocks will remain useful in the rebalancing of his portfolio is because of the assumption that he will continue adding to that fund with his fairly large income. If the assumption is that he won't be adding to that fund but only living off the income, then that would factor into a different answer
    – CQM
    Commented Nov 1, 2011 at 14:32
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    That is not a valid assertion. For one, he doesn't actually say that he was going to add more money in the future, and in the context of this question it doesn't matter. For another, "invest over time" is not equivalent to "dollar cost average".
    – jprete
    Commented Nov 1, 2011 at 14:37
  • okay, dollar cost averaging involves a fixed dollar amount AND being indiscriminate of equity price. Investing over time simply will involve being indiscriminate of equity price. You're right, TOTALLY different concepts, I said the wrong word, my entire premise is invalidated now, even though the rest of it is severable from that one misuse of the term and retains the same context
    – CQM
    Commented Nov 1, 2011 at 16:08
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You have to understand what risk is and how much risk you want to take on, and weight your portfolio accordingly. I think your 80/20 split based on wrong assumptions is the wrong way to look at it. It sounds like your risk appetite has changed.

Risk is deviation from expected, so risk is not bad, and you can have cases where everyone would prefer the riskier asset.

If you think the roulette table is too risky, instead of betting $1, stick 50c in your pocket and you changed the payoffs from $2 or 0 to 50c or $1.50

If your risk appetite has changed - change your risk exposure. If not, then all you are saying is I bought the wrong stuff earlier, now I should get out.

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