Posted on: December 1st, 2022
When the Super Rich—those with a net worth of $500 million or more—want to access capital or borrow to pay for a big purchase, they often tap one of the lowest-cost sources of financing there is: themselves.
These wealthy individuals are able to quickly gather significant sums of cash by using securities-based loans—borrowing against the value of assets in their investment portfolios, often at favorably low rates. Such loans can enable borrowers to delay capital gains taxes, keep money in the financial markets to pursue growth, and fund everything from luxury second homes and vintage automobiles to ownership stakes in businesses.
You may be able to follow in their footsteps and take advantage of securities-based loans for your own spending goals. But should you? Despite their benefits, these loans come with rules and potential pitfalls that you need to understand in order to make the right decision for you.
With that in mind, here’s a closer look at the world of securities-based lending.
The basics of securities-based loans are pretty straightforward—and similar in many ways to how a home equity line of credit works. Rather than sell stocks, bonds or other securities (and potentially pay capital gains tax in the process) to gain liquidity, money is borrowed against the value of the portfolio. Depending on the firm doing the lending and the risk level of the portfolio, you might be able to borrow 60 percent or so of your portfolio’s value. (That percentage can vary significantly, however, based in part on the types of assets being pledged.)
Securities-based lending is hardly a new development in the world of finance. But it’s been in the spotlight in recent years, as rising equity markets and low interest rates have prompted more investors—including those without multiple millions of dollars to their name—to consider tapping into their paper wealth. Here are some of the ways we’ve seen investors take advantage of securities-based loans:
Important: Things you can’t do with a securities-based loan include purchasing or trading securities, refinancing or repaying an existing margin loan, or repaying any other loan used for securities purchases.
Investors with enough wealth to use securities-based lending cite several reasons for choosing that route over other options, including:
Some investors have longer-term tax mitigation in mind when they take out a securities-based loan, via a strategy that’s come to be known among the affluent as “buy, borrow, die.”
The idea is that if you borrow against a portfolio but never sell the assets backing the loan, the cost basis of those securities will “step up” at death—allowing the borrower to avoid paying capital gains taxes on the assets, as well as avoid paying taxes on the amount borrowed. What’s more, the heirs who inherit the assets start at the new, stepped-up tax basis—meaning they could potentially avoid paying a fortune in taxes if they sell.
This benefit has been the target of debate among lawmakers, so it makes sense to consult with a tax professional for the latest developments and guidance.
As is the case with just about any loan, there are potential risks associated with securities-based lending. If you consider this approach, be clear on the possible pitfalls and limitations—which can include:
Securities-based loans are one way to make debt work in your favor. And while you do need significant assets to use this approach, your last name doesn’t have to be Musk, Buffett or Bezos to make it happen. That said, using leverage can add risks to your overall financial picture—a fact that some investors too easily overlook.
Best bet: Consider your financial wants and needs, as well as your financial health and market conditions, to determine whether securities-based lending makes sense for you and your family.
This report was prepared by, and is reprinted with permission from, VFO Inner Circle. AES Nation, LLC is the creator and publisher of VFO Inner Circle reports.
Disclosure: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.
Fusion Wealth Management is not affiliated with Kestra IS or Kestra AS. https://www.kestrafinancial.com/disclosures
VFO Inner Circle Special Report
By Russ Alan Prince and John J. Bowen Jr.
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