Sell Stock: the 1 & 80 Rule

I saved up over the last few years in a fund called optimistically, "House Fund." I knew I'd want a downpayment on a house at some point, and with real estate prices rising, it needed to be invested in the market to keep up with house prices and avoid losing value from inflation.

It has gained about 25% in value over the time I have invested, but now that I'll need some of it for the Cabin project in the next year, it's time to cash out.

My 1 & 80 rule: if you are within 1 year of the event (whether it's a home, wedding, car, or boob job) and you're 80% sure it's going to happen, you should get your cash in order. This means selling stocks (bonds and CDs are generally fine).

I take a moderate view of when to sell stocks to fund a purchase. As the Motley Fool points out in this article, if you wait until closing day to sell, you risk the stocks declining in value and not being able to fund your home purchase. While Fool indicates that you should sell once you make an offer, I would walk that back in the timeline and say that you should sell once you're within 1 year and 80% certainty.

For me, that 80% connects to specific milestones. When I say 80% I mean: I'm pretty sure I will spend the money and know roughly the amount. I've set a budget and I'm actively looking at properties and learning about the local market. It means if I don't get an accepted offer on one, I'm going to keep looking and offer on a different one. That level of certainty.

Sure, you could be less conservative. Or more conservative. If you're retired and you don't have much income or timeline flexibility, you'd probably want to pull that money out sooner. And you could be more aggressive - if the bank of mom & dad is cash-rich and happy to help, you may not need to manage things as tightly.

But here's my reason for being conservative. Remember 2008? The Black Eyed Peas, the writers strike, the global financial crisis... Finance textbooks and articles love the crisis, and for good reason. It's easy to make your point based on the drama of the numbers involved.

But I can do better, because of March 2020 and the Covid-19 pandemic flash crash. I'm going to illustrate my point by running a few scenarios that show what happened if your closing was around that date. 

Imagine you need a $40,000 lump sum for your big expense. Let's run some scenarios, assuming you've made a moderate investment choice and your downpayment was invested in an ETF tracking the Dow Jones Industrial average. Your February 2020 balance of $40,000 would be worth about $26,400 on March 23, 2020 - two thirds of its pre-crash value.

Scenario 1: Your closing is the morning of March 24th, 2020. The flash crash just happened yesterday but you had to pull out your savings anyway because you need that cash today. You're $13,600 short on your downpayment due tomorrow so you can't close the deal, or you have to sell even more stock at the bottom of the market to make up the full downpayment you need and you end up taking those 34% losses on even more of your savings.

Scenario 2: Your closing is the morning of March 24th, 2020. You were 80% sure last year that you were going to buy a house, so you pulled those same stocks out of the market and stuck it in a high interest savings account or CD where it earned a measly 1% interest for the entire year. When you sold your stocks last year on March 24, 2019 those same stocks were worth about $36,500, and with your disappointing interest rate you're at about $36,835. You were $3,175 short of your downpayment, with a year to increase your savings.

Scenario 3: It's March of 2020 and your closing is about a year away, in March of 2021. You know your budget and have started to look at properties. You decide that you should probably convert your downpayment into cash. The flash crash happens, and like a reasonable person, you don't suddenly sell everything at the bottom. You sit tight. In a few days one of the most dramatic recoveries in history begins - you sell your stocks about a month later in April because it's time to get out of this volatile market. You get $33,600. You're $6,400 short on your downpayment, but you have a year to figure out how to save up the cash.

In these scenarios, you're always a little short on your downpayment versus the ideal. That's because it's impossible to time the market and sell at the exact right time. But the benefit of selling your stocks a year out is that you get a clear picture of the gap, and the goalpost won't move. If you can save enough to fill the gap in that year, you can make your downpayment.

In my case, I will be closing in about a month, and it's a cash deal so I now have 100% of the price in a savings account. If the purchase falls through, I'll have lost out on the profits from August stock market performance, but on the other hand if the market tanks I can still buy my property.

All investment involves risk, but your choices can increase or decrease the level of risk (and reward). As I get nearer to the time my money is needed, I want to reduce risk and chance of loss. This reduces chance of profit as well, but if I need huge profits to fund a purchase that is coming up within a year, I should seriously question whether I am financially and emotionally prepared to make that purchase.