Leveraging Your Assets to Manage Your Wealth
Over the long term, cash returns have historically underperformed stocks and fixed income. That's why seasoned investors put most of their wealth in assets with greater earning potential. The downside of doing so, however, is that liquidity can be hard to come by.
Many people whose net worth is in the millions have relatively few liquid assets. So when they need cash, they generally have two options: sell those assets, which could trigger taxes and preclude future growth; or leverage those assets—which can keep their wealth invested for potential long-term growth and meet their short-term cash needs.
While the latter can be an attractive option, borrowing against your investments can be risky. Keeping that in mind, here are four situations in which strategic borrowing may make sense.
Scenario 1: Paying taxes
Without ready access to cash, investors are sometimes forced to sell assets to cover a pressing tax bill—which can trigger its own taxable event. Borrowing can help you pay a tax liability without incurring additional tax liabilities.
However, even those with the cash on hand may find it more advantageous to borrow funds to pay taxes. Consider a business owner who sells an interest in her company for a $2 million profit. She could use the proceeds to pay the long-term capital gains tax obligation of 20%, or $400,000—plus a 3.8% net investment income tax if her adjusted gross income is more than $200,000 (more than $250,000 for married filing jointly). Alternatively, she could borrow against her assets—such as her home's equity or her investment portfolio—allowing her to keep cash for liquidity needs or even invest the proceeds from the sale for long-term growth.
Be aware, however, that borrowing against your investment portfolio exposes you to additional risk in the event of a market decline. If the value of your collateral assets falls below a minimum threshold, you may be forced to deposit additional funds or face liquidation, which can have tax consequences. Similarly, borrowing against your home's equity means using your home as collateral; if the property's value falls, you could potentially owe more than the home is worth—and missing scheduled payments could lead to losing your home. (See "Evaluating your options.")
Potential borrowing solutions
- Home equity line of credit
- Securities-based line of credit from a bank
Scenario 2: Purchasing additional investments
A silver lining of a market downturn is a potential opportunity to "buy the dip." When valuations are down, purchasing additional securities with borrowed funds—such as a margin loan from a brokerage—can let you "strike while the iron is hot," so to speak. If and when the market recovers, you could come out ahead if your investments experience a higher rate of return than what you're paying in interest. Plus, you may be able to deduct the interest paid on the loan up to the amount of investment income earned, effectively lowering your total lending costs. Not all borrowing strategies apply, however; a nonpurpose securities-based line of credit issued by a bank cannot be used to purchase or carry securities. (See "Evaluating your options.")
Before considering a margin loan from a broker, you should determine how the use of margin fits your own investment philosophy. Because of the risks involved, it is important that you fully understand the rules and requirements of trading securities on margin. Some other important considerations are:
- Margin trading increases your level of market risk, and your downside risk is not limited to the collateral value in your margin account.
- Your broker may initiate the sale of any securities in your account to meet a margin call or increase its house" maintenance margin requirements at any time, and is the broker is not required to provide you with advance notice.
- You are not entitled to an extension of time on a margin call.
Potential borrowing solution
- Margin loan from a brokerage firm
Scenario 3: Buying real estate
Borrowing against your assets is also a way to enter a competitive real estate market. In hot housing markets, many people borrow against their portfolios to make their purchase offers more competitive. While they could finance the purchase using a traditional mortgage, an all-cash offer—without the usual contingencies—is generally more attractive to sellers. In such cases, the buyer might refinance to a fixed-rate mortgage in the future or use the sale of their previous home to pay off the loan.
That said, most asset-backed borrowing solutions charge variable interest rates, making them less than ideal for long-term financing. Plus, there's no guarantee you'll be able to obtain a mortgage in the future on the terms you seek. Additionally, securities-based loans are subject to risks, including the lender's right to demand immediate repayment of obligations or the pledging of additional collateral. Failure to meet such demands may result in liquidation of your collateral. (See "Evaluating your options.")
Potential borrowing solutions
- Home equity line of credit
- Margin loan from a brokerage firm
- Securities-based line of credit from a bank
Scenario 4: Managing cash flow
People who receive a majority of their income from cash bonuses and company stock may find borrowing an attractive way to manage their cash flow. For example, many highly compensated individuals receive a relatively modest base pay that doesn't fully support their lifestyle, so they sometimes require short-term financing until they receive their bonus. Of course, they could sell existing stock to meet their spending needs, but doing so would prompt a taxable event and eliminate the future earning potential of those assets. In such cases, borrowing against your assets—such as your home's equity or your investments—to meet liquidity needs could be a preferable solution.
Now, we're not suggesting you borrow to pay the electric bill—your regular income should be able to cover everyday expenses. But for big-ticket items like a new car or major home improvements, leveraging assets can allow you to generate the necessary liquidity without divesting yourself of stock or other investments. (See "Evaluating your options.")
Note that you'll generally be able to borrow less against a portfolio that's highly concentrated in a single stock than one with more-diversified holdings. And you can't leverage restricted shares, which are subject to blackout periods and other constraints.
Potential borrowing solutions
- Home equity line of credit
- Margin loan from a brokerage firm
- Securities-based line of credit from a bank
Review your borrowing strategy
A financial planner or wealth advisor can help you find the right lending solution and create a plan for managing debt effectively.
As part of your plan, be sure to regularly evaluate whether the loan still makes sense in the current environment. The goal is to maximize your wealth over time. If your borrowing costs begin to exceed what those funds can earn elsewhere, it might be time to reexamine your strategy.
Evaluating your options
Whichever route you take, it's important to give yourself sufficient breathing room. Margin loans from a brokerage firm and securities-based lines of credit from a bank, in particular, are subject to market pricing, and if your asset value moves lower, your available credit will shrink. Depending on your risk capacity and tolerance, you may want to consider adding more marginable securities than strictly necessary, so you can have ample cushion against market volatility.
" role="dialog" aria-label="Depending on your assets and goals, you may have several borrowing options available to you.
- Home equity line of credit (HELOC): A HELOC allows you to borrow against the value of your primary or secondary residence. Borrowing limits vary based on your credit rating and your home's value at the time of the line's creation, but the limit will not change even if your property's value declines. Interest rates typically are variable but are often lower than those charged by credit cards or personal loans. You can use the funds for many purposes, such as to pay a tax bill or cover a large purchase. (Funds from a HELOC issued by Schwab Bank cannot be used to purchase Schwab securities or pay off a Schwab margin loan.)
- Margin loan from a brokerage firm: Although they can be used for any purpose, margin loans—in which your brokerage firm lends you money against the value of eligible stocks, bonds, and other holdings in your nonretirement portfolio—are most often used to purchase additional securities. A loan typically requires a minimum of $2,000 in cash or securities, and generally is limited to 50% of the investments' value. If the assets drop below 30% of their original value, your broker may require you to deposit additional funds or securities or sell some of the assets held in your account in what is known as a maintenance call. The interest you pay may be tax-deductible up to the amount of investment income you earn.
- Securities-based line of credit from a bank: Like a margin loan, this line of credit allows you to borrow against the value of your non-retirement investments, usually at a variable interest rate. Unlike margin, however, these credit lines are designated as "non-purpose" loans, meaning they may not be used to purchase securities or pay down margin loans, nor can the funds be deposited into a brokerage account. Such lines of credit also tend to require more assets than a margin account (Schwab Bank's Pledged Asset Line®, for example, has a minimum loan value of collateral of $100,000). A securities-based line of credit can be used for a wide range of financial needs including paying a tax bill, as a bridge loan when financing real estate, college tuition, and more. Keep in mind, however, that these types of credit lines carry a high degree of risk and require that you keep securities pledged as collateral in a separate brokerage account maintained by a broker-dealer that may be affiliated with the bank (as is the case with Schwab Bank's Pledged Asset Line and the accompanying Pledged Account at Schwab).
Whichever route you take, it's important to give yourself sufficient breathing room. Margin loans from a brokerage firm and securities-based lines of credit from a bank, in particular, are subject to market pricing, and if your asset value moves lower, your available credit will shrink. Depending on your risk capacity and tolerance, you may want to consider adding more marginable securities than strictly necessary, so you can have ample cushion against market volatility.
" id="body_disclosure--media_disclosure--89091" >Depending on your assets and goals, you may have several borrowing options available to you.
- Home equity line of credit (HELOC): A HELOC allows you to borrow against the value of your primary or secondary residence. Borrowing limits vary based on your credit rating and your home's value at the time of the line's creation, but the limit will not change even if your property's value declines. Interest rates typically are variable but are often lower than those charged by credit cards or personal loans. You can use the funds for many purposes, such as to pay a tax bill or cover a large purchase. (Funds from a HELOC issued by Schwab Bank cannot be used to purchase Schwab securities or pay off a Schwab margin loan.)
- Margin loan from a brokerage firm: Although they can be used for any purpose, margin loans—in which your brokerage firm lends you money against the value of eligible stocks, bonds, and other holdings in your nonretirement portfolio—are most often used to purchase additional securities. A loan typically requires a minimum of $2,000 in cash or securities, and generally is limited to 50% of the investments' value. If the assets drop below 30% of their original value, your broker may require you to deposit additional funds or securities or sell some of the assets held in your account in what is known as a maintenance call. The interest you pay may be tax-deductible up to the amount of investment income you earn.
- Securities-based line of credit from a bank: Like a margin loan, this line of credit allows you to borrow against the value of your non-retirement investments, usually at a variable interest rate. Unlike margin, however, these credit lines are designated as "non-purpose" loans, meaning they may not be used to purchase securities or pay down margin loans, nor can the funds be deposited into a brokerage account. Such lines of credit also tend to require more assets than a margin account (Schwab Bank's Pledged Asset Line®, for example, has a minimum loan value of collateral of $100,000). A securities-based line of credit can be used for a wide range of financial needs including paying a tax bill, as a bridge loan when financing real estate, college tuition, and more. Keep in mind, however, that these types of credit lines carry a high degree of risk and require that you keep securities pledged as collateral in a separate brokerage account maintained by a broker-dealer that may be affiliated with the bank (as is the case with Schwab Bank's Pledged Asset Line and the accompanying Pledged Account at Schwab).
Whichever route you take, it's important to give yourself sufficient breathing room. Margin loans from a brokerage firm and securities-based lines of credit from a bank, in particular, are subject to market pricing, and if your asset value moves lower, your available credit will shrink. Depending on your risk capacity and tolerance, you may want to consider adding more marginable securities than strictly necessary, so you can have ample cushion against market volatility.