Stuck with an unexpected expense? Here’s how to decide how to cover it.

Key points

• When unexpected bills arise, it’s hard to know how to pay them.
• In most cases, you’re better off tapping into your emergency savings, but there may be exceptions.

You never know when an unexpected bill might land in your lap, whether it’s a car repair, home repair, or hospital bill. It is important to maintain a strong emergency fund so that you are always prepared.

As a general rule, you should aim to have three to six months of living expenses in your savings account. Not only could this money help you with an unexpected bill, but it could also help you overcome a period of unemployment.

But your emergency fund may not be your only source of money if an unexpected bill hits you. If you hold investments in a traditional brokerage account (as opposed to a retirement plan, like an IRA), you are allowed to cash out those investments at any time without penalty. If a need for cash arises, you may be torn between dipping into your savings account and liquidating certain stocks.

In most cases, it is usually better to raid your emergency fund in this situation than to cash in investments. But there may be some exceptions.

The problem of liquidating investments

The advantage of keeping money in the bank is that you don’t have to worry about losing any of your main deposit until you make a withdrawal. With an investment account, the value of your balance can fluctuate based on market performance.

The problem with selling investments to access cash is that you risk locking in losses by selling them when they are down. And that’s one reason why tapping into your emergency fund is usually best when you need the money.

Let’s say there is a company of which you own 10 shares which you bought for $200 each. If, at the time you need the money, those stocks are only worth $190 each, cashing in means losing $100 (whereas if you leave those stocks alone, their value could easily go back up in about a week or so).

But even if you plan to sell investments at a profit to access cash, this is not always ideal as it will trigger capital gains taxes. The amount of tax you will be charged for selling investments for profit will depend on how long you held them before the sale. But back to our example, if the 10 stocks you bought at $200 each are now worth $210 each, that’s a gain of $100. And if you cash out, you’ll be taxed on that $100.

In comparison, when you withdraw funds from a savings account, you are not taxed at all. You do not earn money in a savings account other than collecting interest. And while the bank account interest East taxable, withdrawing money from your savings will not increase your tax burden. On the contrary, it should reduce it leaving you with less money to earn interest.

What’s the right call?

If you are sitting on long-term capital gains in your brokerage account (which apply to investments held for at least one year and one day) and you earn less, capital gains taxes may not apply to you. In that case, if you’d rather cash in investments than dip into your emergency savings, go for it. However, be aware that liquidating investments means losing the chance to make them gain more value.

But if you have a good level of emergency savings and investments in a brokerage account, it’s usually best to withdraw from the former when you need the money. Even though long-term capital gains taxes don’t exceed 20% for high earners and most people are subject to a 15% tax rate, it’s silly to pay taxes when instead, you can dip into your emergency fund.

Also, the point of having an emergency fund is to cover unexpected bills. You might as well use that money for its intended purpose so you can grow your investments.