Hello everyone and welcome to this month’s Ask the CFP segment. This month’s question is, “Can I borrow from my own portfolio?” People often associate debt with poor financial decisions. We’re usually taught in our youth that credit cards are bad and paying off your mortgage as quickly as possible is good. While some types of debt are certainly bad, using debt as leverage for other financial strategies can be good. Two reasons for using debt include leverage for potentially higher gains and to avoid taxation.
Many 401(k) plans in America allow employees to borrow against their retirement plans. While I’m generally not a fan of this strategy, one reason some people use 401(k) loans instead of early withdrawals is to avoid triggering income taxes. The IRS views borrowing differently than distributing. While 401(k) loans are common knowledge, two lesser-known strategies to borrow against one’s portfolio also exist. Keep in mind, these only exist for taxable, non-qualified investment accounts, not IRAs.
First, investors can establish what’s called a securities-based line of credit. If someone has $1 million in an investment account, they can pledge their investment account as collateral on a loan. Banks will review the types of investments held in the account to determine how much it may fluctuate. An account with all stocks will obviously fluctuate more than an account with all bonds, so banks may be willing to lend more for portfolios with less volatility. A $1 million portfolio with a mix of stocks, bonds and real estate might be approved for $700,000, for example. Once approved, these dollars can’t be used to buy more investments, but they can be used for home improvements, buying real estate, business ventures and more. Monthly payments are generally interest-only, but principal can be paid back at any time and even re-borrowed again later.
Second, investors can establish margin loans on their non-qualified investments. Similar to securities-based lines of credit through banks, brokerage firms make margin loans available to customers based on their account balances. You can generally borrow up to 50% of the value of your investments on a margin loan. This type of loan doesn’t require a lengthy underwriting process or a credit check, so it’s generally much easier to establish. Interest accrues to the account and the brokerage firm will let you know if you need to add cash or sell securities to maintain enough equity in the account.
These two types of borrowing methods can be wise in a low interest rate environment. If someone needs cash to buy a home before they’ve sold their current home, they might consider selling some of their investments. However, if that would trigger taxable gains, it may be a poor choice for a short-term cash need. That’s one reason why borrowing against a portfolio can make financial sense. These loan types typically offer more competitive interest rates than traditional financing thanks to the investments that back up the loan. It’s less risk for the lender, so they generally offer a competitive interest rate.
So can you borrow from your own portfolio? If you have non-qualified assets, yes, it’s an option and one you should consider if you need cash and want to avoid taxes on appreciated assets. Leveraging debt is completely fine if used wisely. If you have a question about this topic or have a question for next month’s video, please send it to TFreeman@MonetaGroup.com. Thanks for watching and we’ll see you next month.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please speak with a qualified tax or legal professional before making any changes to your personal situation.
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