Need Money, But Don't Want To Sell Investments?

If I’ve said it once, I’ve said it a thousand times—we’re long-term investors with long-term financial goals. We think in decades, not days, weeks, or months. But sometimes, you need a single or series of withdrawals from your portfolio for near-term needs.  

The obvious example is retirement: taking out 4% to 5% per year from your portfolio is standard on a monthly or quarterly basis.

But what about other expenses? A big vacation, buying a rental property, or making improvements on your home? What if you’re moving and want to use proceeds from your current (unsold) house for the downpayment on the new place? How about an unexpected business opportunity you don’t want to miss? Or maybe you had a surprise tax hit from that long-overdue bonus or an inheritance?

In each case, you could take money out of your investment portfolio. Of course, taking it from your taxable (or trust) account is more accessible than your IRA because of the tax consequences—you pay long-term capital gains tax on gains in taxable accounts but ordinary income tax on IRA withdrawals.

What if you don’t want to pull money from your portfolio? Maybe you don’t want to pay any tax on withdrawals from your investment portfolio. Or perhaps you hold a 100% stock allocation, and you need money at a time when stocks are experiencing a temporary bear market?

There are several options. If your taxable account allows margin, you could borrow against the value of your investments; however, the interest costs are pretty high—6% to 7% annually. You could also utilize a Home Equity Line of Credit (“HELOC”); these have much lower rates but are cumbersome to set up and only available if you have significant equity in your home.

There is a third option that is very common amongst Servo clients, but that, until now, I’ve only talked about reactively when the liquidity issue comes up in client conversations. That option is a Pledged Asset Line of Credit, or “PAL.” A PAL works a lot like a HELOC, except the collateral you are pledging to back your loan is your investment portfolio, and specifically your taxable account. You are not allowed to pledge retirement accounts (IRAs, SEPs, 401ks, etc.).

It works as follows: You apply with Schwab Bank for the Pledged Asset Line (I help you set this up) in the amount you need and that you can afford based on the amount of assets you can pledge. You get a new Schwab account in about 30-45 days, identically registered as your existing taxable account. We move investments over into this new account that are sufficient to collateralize the line. To start, you need to have approximately 140% of the value of your pledged asset line in investments in your Pledged Asset Brokerage Account (to establish a $100K pledged asset line, you need $140K in investments). You can wire money out of your pledged asset line, and you also get a checkbook if you prefer accessing funds that way. You only pay interest once you access your funds, not before. The only obligation is that you make either interest-only or interest and principal payments over an extended period.

The best part of a Pledged Asset Line of Credit is that the rates are low, and you don’t have to go through the hassle of a HELOC and involving your home equity. To read up on the details of PAL accounts and terms, and to see current interest rates for different loan amounts, click here.

One aspect of PAL accounts that confuses people is the amount you should borrow. It actually makes sense to get a line for the most amount that your collateral (investments) would allow with a PAL account. Why? The rate on whatever you borrow will be lower.

Here’s an approximate example from a recent client: They wanted $150K that they would be able to pay back in a year, but they didn’t want to take substantial capital gains from selling their DFA stock funds. Instead of setting up a $150K or $200K pledged asset line, they established a $1M line. Why? The rate on lines over $1M is the Overnight Lending Rate (almost zero) + 2.4% per year. On a $100K to $250K line, the rate was OLR + 4.65%. It didn’t matter that they would never take anything close to $1M out, by getting the bigger line, they would pay less interest; this strategy would save them over $3,300 in interest costs over the next year.

To keep this note brief, I won’t go into all the details around PAL accounts. Suppose you’ve been thinking about an upcoming expense or would like to draw out some of your investment funds but have been delaying/avoiding contacting Servo because you didn’t want to face the tax hit. In that case, we should discuss alternative ways to get you money. A PAL could very well be a good option for you.

Want to know more about PAL’s (or anything else)? Let’s talk. Email me, and we’ll chat…