Withdrawing cash from investment: take money from underperforming fund?
It looks like the advice the rep is giving is based primarily on the sunk cost fallacy; advice based on a fallacy is poor advice. Bob has recognised this trap and is explicitly avoiding it. It is possible that the advice that the rep is trying to give is that Fund #1 is presently undervalued but, if so, that is a good investment irrespective if Bob has lost money there before or even if he has ever had funds in it. "The root of the advice Bob is being given is from the premise that the market is temporarily down.    If the market is temporarily down, then the stocks in ""Fund #1"" are on-sale and likely to go up soon (soon is very subjective).     If the market is going to go up soon (again subjective) you are probably better in fictitious Fund #1.    This is the valid logic that is being used by the rep.   I don't think this is manipulative based on costs.    It's really up to Bob whether he agrees with that logic or if he disagrees with that logic and to make his own decision based on that. If this were my account, I would make the decision on where to withdraw based on my target asset allocation. Bob (for good or bad reasons) decided on 2/3 Fund 1 and 1/3 Fund 2. I'd make the withdraw that returns me to my target allocation of 2/3 Fund 1 and 1/3 Fund 2. Depending on performance and contributions, that might be selling Fund 1, selling Fund 2, or selling some of both." "Bob should treat both positions as incomplete, and explore a viewpoint which does a better job of separating value from volatility. So we should start by recognizing that what Bob is really doing is trading pieces of paper (say Stocks from Fund #1 or Bonds from Fund #2, to pick historically volatile and non-volatile instruments.*) for pieces of paper (Greenbacks).  In the end, this is a trade, and should always be thought of as such.  Does Bob value his stocks more than his bonds?  Then he should probably draw from Fund #2.  If he values his bonds more, he should probably draw from Fund #1. However, both Bob and his financial adviser demonstrate an assumption: that an instrument, whether stock bond or dollar bill, has some intrinsic value (which may raise over time).  The issue is whether its perceived value is a good measure of its actual value or not. From this perspective, we can see the stock (Fund #1) as having an actual value that grows quickly (6.5% - 1.85% = 4.65%), and the bond (Fund #2) as having an actual value that grows slower (4.5% - 1.15$ = 3.35$).  Now the perceived value of the stocks is highly volatile.  The Chairman of the Fed sneezes and a high velocity trader drives a stock up or down at a rate that would give you whiplash. This perspective aligns with the broker's opinion.  If the stocks are low, it means their perceived value is artificially low, and selling it would be a mistake because the market is perceiving those pieces of paper as being worth less than they actually are.  In this case, Bob wins by keeping the stocks, and selling bonds, because the stocks are perceived as undervalued, and thus are worth keeping until perceptions change. On the other hand, consider the assumption we carefully slid into the argument without any fanfare: the assumption that the actual value of the stock aligns with its historical value.  ""Past performance does not predict future results.""  Its entirely possible that the actual value of the stocks is actually much lower than the historical value, and that it was the perceived value that was artificially higher.  It may be continuing to do so... who knows how overvalued the perceived value actually was!  In this case, Bob wins by keeping the bonds.  In this case, the stocks may have ""underperformed"" to drive perceptions towards their actual value, and Bob has a great chance to get out from under this market. The reality is somewhere between them.  The actual values are moving, and the perceived values are moving, and the world mixes them up enough to make Scratchers lottery tickets look like a decent investment instrument.  So what can we do? Bob's broker has a smart idea, he's just not fully explaining it because it is unprofessional to do so.  Historically speaking, Bobs who lost a bunch of money in the stock market are poor judges of where the stock market is going next (arguably, you should be talking to the Joes who made a bunch of money. They might have more of a clue.).  Humans are emotional beings, and we have an emotional instinct to cut ties when things start to go south.  The market preys on emotional thinkers, happily giving them what they want in exchange for taking some of their money.  Bob's broker is quoting a well recognized phrase that is a polite way of saying ""you are being emotional in your judgement, and here is a phrasing to suggest you should temper that judgement."" Of course the broker may also not know what they're doing!  (I've seen arguments that they don't!)  Plenty of people listened to their brokers all the way to the great crash of 2008.  Brokers are human too, they just put their emotions in different places.  So now Bob has no clear voice to listen to.  Sounds like a trap! However, there is a solution.  Bob should think about more than just simple dollars.  Bob should think about the rest of his life, and where he would like the risk to appear.  If Bob draws from Fund #1 (liquidating stocks), then Bob has made a choice to realize any losses or gains early... specifically now.  He may win, he may lose.  However, no matter what, he will have a less volatile portfolio, and thus he can rely on it more in the long run. If Bob draws from Fund #2 (liquidating bonds) instead, then Bob has made a choice not to realize any losses or gains right away.  He may win, he may lose.  However, whether he wins or loses will not be clear, perhaps until retirement when he needs to draw on that money, and finds Fund #1 is still under-performing, so he has to work a few more years before retirement.  There is a magical assumption that the stock market will always continue rewarding risk takers, but no one has quite been able to prove it! Once Bob includes his life perspective in the mix, and doesn't look just at the cold hard dollars on the table, Bob can make a more educated decision.  Just to throw more options on the table, Bob might rationally choose to do any one of a number of other options which are not extremes, in order to find a happy medium that best fits Bob's life needs: * I intentionally chose to label Fund #1 as stocks and Fund #2 as bonds, even though this is a terribly crude assumption, because I feel those words have an emotional attachment associated to them which #1 and #2 simply do not.  Given that part of the argument is that emotions play a part, it seemed reasonable to dig into underlying emotional biases as part of my wording.  Feel free to replace words as you see fit to remove this bias if desired." I think that Bob has good reasons for his planned spending and should follow his plan, not the dubious advice from an account rep. I think the advice Bob is being given is good. Bob shouldn't sell his investments just because their price has gone down. Selling cheap is almost never a good idea. In fact, he should do the opposite: When his investments become cheaper, he should buy more of them, or at least hold on to them. Always remember this rule: Buy low, sell high. This might sound illogical at first, why would someone keep an investment that is losing value? Well, the truth is that Bob doesn't lose or gain any money until he sells. If he holds on to his investments, eventually their value will raise again and offset any temporary losses. But if he sells as soon as his investments go down, he makes the temporary losses permanent. If Bob expects his investments to keep going down in the future, naturally he feels tempted to sell them. But a true investor doesn't try to anticipate what the market will do. Trying to anticipate market fluctuations is speculating, not investing. Quoting Benjamin Graham: The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell. Assuming that the fund in question is well-managed, I would refrain from selling it until it goes up again.
The main reasons are that investment are deducted from your gross income and earnings are not taxed until withdrawal. This applies to both traditional IRAs and 401Ks. Roth accounts have different rules but valuable benefits. My effective income tax rate is around 35%. This means that for every $1000 I earn in wage I only get to keep $650. Since my 401K contributions are deferred reductions from my income I can invest 35% more money into my 401K than I would be able to invest in a non-tax-advantaged account. Where I can invest $1000 into my 401K I would only be able to invest $650 into a non-advantaged account with the same wages. If I put $650 into an account yielding 10% then my one-year return on my income is $65 The 10% return on my $1000 is $100. Compared to what I would have been able to take home in the first place this makes my ROI $100/$650 = 15.3% Interest earned in non-advantaged accounts incurs taxes every year. Interest earned in advantaged accounts does not incur taxes until withdrawn. Compounding 10% annually for 20 years is significantly more than 6.5% compounded annually for 20 years. Imagine 10% on a 1000 investment with no additional cash flows over 20 year. The result is $6727, or 672%. Imagine your income tax rate does not reduce below 35%, your after-tax return is 4372, or %437 return. Now imagine you pay taxes every year on 10% take, so your take annually is only 6.5%... Now over 20 years you have $3523 (but you've already paid all taxes on this) and your return is %352 You have earned 24% more money because taxes were deferred until withdrawal! EDIT: Some tabular info for the commenters Your take home from the investment is $3752 because you have diligently paid your taxes every year on the earnings. Now, with the tax deferred until withdrawal! You then owe 35% tax on the withdrawal so you keep 7400 * .65 = $4810 $4810 versus $3750 means you have made an additional $1060, or 28%, from the compounding against tax-advantaged earnings. But Matthew! you say... Annual proceeds from your investments are not taxed at your income tax rate. This is true for now but the political winds are pushing this direction. However, even if you use a reduced rate in the first situation (let's say 30% instead of 35%, if you're a California resident) then the effect is $4140 rather than $3750. Less of a gain, but still a gain. In fact your capital-gains rate would have to be as low as 22% to even this difference out (versus a 35% income tax rate).... And remember that this assumes you're in the same bracket at retirement (which more people are not) You may also note that I used $1000 as the principle in both calculations. This was intentional to show the effects of compounding the taxable earnings alone. If you replace the taxable principle with $650 instead of $1000 then the effect is even more pronounced and only balanced out if your capital gains rate is actually zero! Not exactly. There are a few ways to manage your taxes with investments. 1) For most investments you get taxed on any gain in value in the investment or dividends paid by that investment. Most investments (with some exceptions for mutual funds) you don't take the tax hit until you sell the investment and realize the gain. For bonds, cds, and other cash type investments you have to pay taxes in the year they pay out the interest or dividend. 2) You can put money (up to a certain limit) in a traditional IRA and can subtract that amount from your income for tax calculation for the year you invest it. However, you are going to pay taxes on it when you take the money out at retirement. It really just delays the taxes. 3) If you put the money in a Roth IRA, you don't get a tax break now, but you don't have to pay any taxes on the money or the gains when you take it out at retirement. 4) The gains from some mutual funds can be tax exempt, but that just saves you from paying tax on the increase in value.  5) Don't fall for scams that try to use insurance policies as investments to avoid taxes. The fees are ginormous, which usually makes them a ripoff. By definition, actively managed funds will underperform passive index funds as a whole. Or more specifically: The aggregate performance of all actively managed portfolio of publicly-tradable assets will have equal performance to those of passively managed portfolios. Which taken with premise two: Actively managed funds will charge higher fees than passively managed funds Results in: In general, lower-fee investment vehicles (e.g. passive index investments) with broad enough diversification to the desired risk exposure will outperform higher-fee options But don't take my wonkish approach, from a more practical perspective consider: This might be better suited to r/personalfinance but if you're looking to invest I'd say start with an index fund. The MER's (fees) for most other mutual funds take too heavy a chunk of returns to be worth it in a market where actively managed funds are either underperforming of performing at par with passive funds.   Additionally if these are your first investments, make sure you're doing it with investment goals in mind. Is this money you're saving for short, medium, or long term? For medium and long term investing make sure you're doing it through a tax efficient instrument like an IRA or 401k. My take is that he can avoid a big tax hit by leaving it as and giving   the untouched fund to the heirs. 100% correct. By withdrawing now he'll be subjected to the income tax on the gains. Since his gains are almost the whole value of the account, he'll actually find himself in the highest bracket, not the lowest as Joe suggests. Not only that, but his SS income will become taxable as well. Capital gains are included in the AGI. By leaving as is, the heirs will get stepped up basis, and the whole 700K will not be taxed (its below the estate tax threshold, and the basis for the heirs will be the value at death). How does one buy this quantity of TIPS? Do you simply buy directly from the US Treasury? You will might have to go through a financial institution like a broker or a bank. Edit: You can also buy bonds directly with TreasuryDirect. Is it cheaper to buy a fund that invests in TIPS? It might be cheaper depending on the fund  itself. But you can't know for sure the price that the fund will be worth at you payout date. Since bonds can go up in value (and are likely to with rates this low), is there a way to measure potential downside? Statistically speaking yes. You can look at the variation in price/interest of the bonds in the last years, to see how they usually move, then compute the price range where they are likely to be (that can be wide for volatile securities). But there is no guarantee that there won't be some black swan event that will make the price shoot up/down. In another word, it's speculation Can I mitigate downside risk by choosing different TIPS maturity? There are quantitative strategies to do that, like finding that some products that are negatively correlated, such that a loss in one is be hedged by a gain in another. However those correlation are likely to be just statistics. And for every product that you buy you are likely to have to pay some fees for your bank/broker which can be more devastating than the inflation itself. Is there some other strategy I should be considering to protect my cash against inflation (or maybe a mixed strategy)? As I wrote above, trying to use complex financial products can incurs loss and will have fees (both for buying and selling). Is it really necessary to hedge from a 2% inflation by taking such risk? Personally, I don't think so. If I were you I would just be buying bonds maturing for your payout date. That would negate the reselling risk and reduce the fees. It would involve manual effort, but there is just a handful of exclusions,  buy the fund you want, plug into a tool like Morningstar Instant X Ray,  find out your $10k position includes $567.89 of defense contractor Lockheed Martin,  and sell short $567.89 of Lockheed Martin.  Check you're in sync periodically (the fund or index balance may change); when you sell the fund close your shorts too. Something with an FDIC guarentee, so a bank. With an emergency fund, I think the 'return of capital' is more important than the 'return on the capital', so I'm fine with putting it in a standard savings account in a local bank(not an internet account) even if it pays next to nothing. The beauty is that since the bank is local, you can walk in and withdraw it all during any weekday.