Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Margin Loans: When Do They Make Sense?
Published Date : May 18, 2015
Over the last few years, we have seen an uptick in clients borrowing against their investment accounts for short-term liquidity needs such as a larger tax payment or a bridge loan to secure a real estate purchase. The option of a margin loan has been more attractive due to historic low interest rates and a more restricted operating environment for banks. While the appeal is understandable, it is important to completely and equally understand the unique risks and benefits associated with such loans. Margin loans can be a great cash flow planning tool for investors with high value and diversified taxable accounts, but only if the ideal loan duration, interest rate environment, and portfolio risk parameters are in place. It should also be noted that long-term or excessive amounts of debt have proven detrimental to the accumulation of wealth.
Custodians such as Schwab and Fidelity will generally allow you to initially withdraw 50% of the account value of marginable securities from your diversified portfolio, typically excluding highly concentrated stocks with limited history or volatile trading patterns. Over time, your loan balance is allowed to reach 70% of the account value; however, should you eclipse this threshold, the custodian will initiate a margin call that requires a cash deposit to the account or the forced selling of securities at an inopportune time to reduce the debt. The most common cause of a margin call is a decline in the portfolio value due to a market downturn. To protect against this risk to a margin borrower, we recommend our clients limit their short-term borrowing to 25% of their portfolio value.
A margin loan is sometimes used in lieu of a home equity line of credit for short term cash needs. A typical cash need would be for a bridge loan to secure a real estate purchase while long term mortgage financing arrangements are being finalized. Borrowers often use the fast access to cash as a way to significantly maximize their cash payment towards a property, increasing the attractiveness of their bid. Other activities where liquidity for one purpose is needed in advance of the liquidity provided by another transaction, provide opportunities to optimize margin borrowing. Education costs, a wedding, or home remodel can all be paid in advance of a future wealth event, such as a 10b5-1 stock exercise, deferred compensation payment or sale of a business, which affords the expenditure.
Current rates on margin loans may be low, but it is important to know that they are not fixed, and therefore are subject to the likely rise in interest rates, specifically the Fed Funds rate against which margin rates are traditionally benchmarked. While not a long term borrowing solution, the greatest benefit of the margin loan is your ability to quickly access funds. Most non-retirement accounts set up through the custodians are already “margin ready” or can be updated with a simple form. Funds can be wired to their destination generally within one business day and will not require the liquidation of securities, which keeps your investment allocation in place and eliminates the need to possibly create taxable gains.
With thoughtful consideration and coordination from your wealth advisor, using an appropriately measured margin loan for a short term borrowing project can be a very powerful tool. Understanding that both market risk and interest rate risk are important considerations and differentiate the margin loan from a traditional fixed mortgage loan will help you determine if and when it may be appropriate for you.
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Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.
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