Using the Equity in Your Investments - A Strategy to Consider

By: Gregory J. Cook, EA, CPA 
 

Many long-term investors find themselves in the same situation when short-term cash needs arise – their assets are tied up in illiquid, long-term investments. If you find yourself in this situation, what can you do? You may need cash for a short-term purpose, such as paying an unanticipated income tax bill. Or you may want to take advantage of the equity in your investments without triggering capital gains taxes. You can also use the value of your securities to take advantage of an investment opportunity. Borrowing against the value of your investments is accomplished by securing a loan using your investments as collateral. This loan is commonly referred to as a margin loan. Before you decide to borrow against the value in your investments, be sure to discuss the pros and cons with your financial advisor.

How it Works

To borrow against the value of your securities, you usually need to fill out an agreement with the institution that holds your investments. There are federal regulations limiting how much you can borrow and which types of securities are available to be used as collateral, and each institution can impose stricter regulations. Consult your financial institution to learn which securities are eligible to borrow against and how much equity is required. When borrowing against the equity in your investments, it is always wise to be prudent. The market fluctuates. It is important to leave a large enough cushion in your portfolio to help protect yourself from having to deposit additional securities to keep the loan in good standing. Once you have established an agreement with your financial institution, you can generally use your account as a line of credit, borrowing against your assets as needed – up to the limit established based on the value of your securities.

Benefits of Loans against Securities

One of the greatest advantages of a margin loan is that you can use the proceeds for almost any purpose, giving you great flexibility when managing your overall finances. Frequently these loans offer competitive interest rates, and the interest you pay may be tax deductible. Typically, loans against securities in your account can be completed in a short time, ideal for immediate cash needs.

Risks

A margin loan can result in financial losses if the market value of your investment portfolio dips below a certain level while the loan is outstanding. When this happens, the broker will issue a margin call and you’ll have to repay all or part of the loan – immediately. You may have no choice but to sell your investments at a loss to meet your obligation. It’s possible to lose more money than you initially invested.

The Big Picture

When deciding how to finance a need for cash, it is important to investigate all your options. How you borrow can be as important to your overall financial picture as how you invest. Discuss your borrowing needs with a qualified financial professional to see if this type of borrowing is right for you.