November 4, 2018
It is very often true what they say: it takes money to make money. Or, said another (slightly different way) – there are many (better) investment strategies and ideas that are only really open to the very wealthy. It used to be, in my experience, that portfolio loans was one of them.
What is a portfolio loan? It is just what it sounds like – you take a loan out against a portfolio of securities. The idea being that you can earn more on that money having it in the market (or doing something else with it) than you pay in interest. This is also referred to as “buying on margin” – although the two ideas are not synonymous. Buying on margin generally refers to a specialized loan that only allows you to buy additional securities. A portfolio loan can be used for anything, really.
Our most common example – you sell a business for a million dollars. You will owe something like $400k in taxes on that and you would have $600k left over to invest/earn with/live on. A very common strategy in the big private bank/rich people world is to put the $1MM you got from the sale into an account, loan you $400k against it (which you use to pay the taxes) and then you are earning on the entire $1MM portfolio. Sure, you have to pay the interest on $400k, but you end up getting to keep the earnings on that $400k. (See my post about leverage and arbitrage).
I just saw this, so it might be old news. But Wealthfront is offering small scale portfolio loans on your portfolios. Think of it like a home equity line of credit, but on your investment account. This is huge. If you have EVER talked to me about finances you have heard me harp on the “stable value” fund. This is an investment account that back stops your cash. I will tend to tell you to have less and less cash on hand over time and have more money in something like a wealthfront (granted at a very low risk profile). It moves around more than the bank but it also earns you WAY more than the bank does.
This sort of portfolio loan means that you can invest more at a slightly higher risk (which means slightly higher reward) and have the ability to borrow short term against the portfolio should have an emergency you need cash for. This means the money gets to do double duty: you can earn more on it while also having it serve as an emergency fund.
BE CAREFUL: These loans are variable rates loans – they will go up (especially in the current environment). They should only be for short term and you need to make sure the “juice is worth the squeeze” – if you have to borrow at 5% and earn at 6% there isn’t enough arbitrage there (1% to make it worth the risk).
But, generally, this is a cool tool that I think could be super useful for many of you. So let me know if you have questions!