Why Liquidity Builds Confidence – Why having access to cash affects how confidently you invest your portfolio
Marcus Schafer
What is the point of saving and investing? It is to spend your money. This can be episode 30 where logic meets life and investing. I’m Marcus Schafer of Greenspring Advisors. Today I’m running solo, no pat, but hopefully you stick with us because what we’re going to be talking about is how to generate short-term temporary cashflow from a portfolio. So think about this as loans from your portfolio, whether that’s your investment portfolio or your house. And this kind of matters to
everybody because one of the most important things if you go back to our last conversation about cash is making sure that you can invest with confidence into your model, get the cash deployed into your model. And one of the things that really helps with that is understanding what tools you might have at your ability to take withdrawals from your portfolio in the most efficient way.
So you can think about this as it really helps with one of the most challenging conversations, which is what do I do with my next dollar of savings? What’s the most efficient thing? And so what we’re going to talk about is what are some ways where we can address that without being overly specific? And one of the real benefits of this, it’s called the Swiss cheese method of risk management. So if you think about a slice of Swiss cheese with the holes in it, imagine the big holes, and what we’re trying to do is overlay
different slices of cheese so that there is less light kind of getting through those big holes. I come from a family of rocket scientists. What they would tell you is it’s very expensive to get a part to 100 % reliability in the difficult challenges of launching something into space. So what do they do? They design two parts that are 98, 99 % reliable and they interlay them. So if one fails, the other one’s likely
Temporary Liquidity vs Permanent Leverage – Why borrowing should be time-constrained and where it can become risky
to save it. Now it’s not perfect, but over time you can get a sense of what is some of the value of just preparing for the unknown. So as we think about some of these tools, I do want to make one quick point that taking a loan from a portfolio should be viewed differently than adding leverage to a portfolio. And the lines can kind of get crossed a little bit. It is a gray area, but we should really be thinking about
temporary, that means time constrained uses of this cash as opposed to I’m going to take money out of my portfolio, which by definition is kind of creating leverage into the portfolio. So the framework that we’re going to do is we’re going to walk through kind of the major tools you can use and we’ve simplified them. They’re not all encompassing. So we’ll walk through the major tools and then we’ll walk through kind of six considerations.
that are really important for investors to think through as they figure out which one of these tools might be best for your specific situation, as they say in economics, there is no solution, there is just trade-offs. And then the last thing we’re gonna do is look at kind of three different case studies, three different use cases that have kind of come across our desk over the past few weeks. So these are kind of live examples, common use cases.
How do we think about evaluating those situations and hey, maybe it applies to you today, maybe it’s gonna apply to you in the future, but just knowing these tools exist should create confidence in your portfolio. Okay, so what are the major frameworks that we can rely on? There’s the first option, which is we could just sell securities from the portfolio, right? Like we have an upcoming cash expense of $50,000, we could just sell $50,000
of stock or bonds and utilize the proceeds to fund that expense. And we could do that really well. could think about going and picking specific tax lots. That means the individual times we purchase those positions, we can maybe do some tax loss harvesting. can rebalance the portfolio. This is actually the answer in most cases. There is just this thought that simplicity, it’s actually elegant and we shouldn’t overlook the fact that
The Four Ways to Access Cash – Selling securities, portfolio lines, HELOCs, and traditional loans
Hey, oftentimes the answer is staring us right in the face. Now there are some more complicated tools we might be thinking about using. One is just a portfolio line. So this is kind of what we were alluding to. This is we’re going to take a loan out against the value of our securities. And I’m going to bucket this into the singular category, but there’s really kind of three different types of tools that fall underneath this. There’s kind of a margin. There’s a securities backed line of credit.
There’s something called a pledged asset line, depending where your money’s held and maybe a specific use case. There are some minor differences, but for the purpose of this, we’ll kind of keep it high level. Another option we have is what’s called a HELOC, a home equity line of credit. So this is borrowing against the equity you’ve built up in your home. Your home is a part of your investment portfolio. We want to take that into consideration. And then the last
kind of tool is just a traditional loan, right? You want to go buy a car. What’s the common way you finance a car? You go get an auto loan. And there’s going to be pros and cons to that. So those are our major tools. You could sell securities. You could get a loan from your portfolio. You could get a loan off of your house or you could just go directly to get a loan. Now, here come the tradeoffs, right? The first tradeoff is origination. How quickly and how easy is it for you to actually get approved?
for one of these loans and get it deployed. That matters. Selling securities, that’s pretty easy, right? It’s your portfolio. You have complete discretion. You can do that essentially most of the time on a daily basis. Portfolio lines ⁓ of credit off of your investment portfolio, that’s actually pretty easy to work through. Key locks, that tends to be some actual underwriting, maybe a hard credit pull. And then traditional loans, obviously, that has a hard credit pull as well.
The second major consideration is going to be cost. And this is probably what people start with, but this is just one of the six considerations. So selling securities, obviously there is a cost. There’s a cost in terms of ⁓ taxes, which we’ll talk about next. There’s also a cost in terms of future expected growth, potentially of the portfolio. Portfolio lines of credit, there definitely is a cost to borrow money.
which is essentially what you’re doing backed by your collateral, which is your investment portfolio. And here is, think, a good point to talk about, maybe the differentiation of types of rates you might get. Greenspring, we just renegotiated our rates that we are getting from custodians on behalf of our clients. When I look at what’s publicly available from the same custodians, it’s about twice as much in terms of fees. You’re kind of looking at maybe
The 6 Tradeoffs That Matter – Origination, cost, taxes, rate structure, behavior, and risk
Cost right now, and this is floating rate, which is another point we’ll get to, but cost right now of call it 6 %-ish versus the publicly available costs of 12 %-ish. There’s definitely different custodians you might be evaluating, but I would point everybody back to this question about, is it a short-term time-constrained loan or is it leverage? And why might somebody be loaning you money at cheap rates?
It’s potential that they make a lot of money if you behave in leverage type investing activity. Key locks, they tend to be a little bit more expensive, but definitely a great use case. then traditional loans, obviously, I think is the baseline that we all kind of start these decisions looking off of. The next category I alluded to it, tax impact. Selling securities oftentimes is going to create a capital gain. So there’s going to be a cost of that.
If you are doing something time constrained, this is one of the mathematical questions we’re trying to evaluate, which is if you’re going to sell something and then buy it back six months later, what’s the taxes you’re paying with that versus the cost of maybe taking out some interest payments? Portfolio lines of credit, they are tax efficient in the sense that you don’t have to sell securities. There’s definitely a cost, and that’s the rate.
HELOCs, there might be actually some tax advantages to these if you’re doing things, if you’re spending the money to reinvigorate or refurbish your house. So there might be some actual benefits of that. Traditional loans, actually was maybe some potential benefits with auto loans that was just come out of the recent tax bill. So tax impact can be a positive, can be a negative. The next consideration is what is the rate
structured, meaning is it a fixed rate or a floating rate? So portfolio lines, there’s going to be floating rate, key locks, there’s going to be floating rate, traditional loans, those are going to be fixed rate. And one of the big considerations we would have people think through is how much of your debt is floating rate? And what could that potentially look like in terms of your sensitivity to rising rate environments?
If your house is on a floating rate setup and you’re also taking out another floating rate loan, could be a potential cause that you might just want to, a potential drawback you want to dive into where a fixed rate gives you some asynchronous protection against rising rates. The next, and this is really, really tough to talk with clients about, but this is the behavioral impact. This is, hey, do we think
that by taking out these loans, it might turn into leverage. Why do I say that? Because of portfolio line of credit, there is no fixed payment terms. You can hold these indefinitely and there could be benefits to holding it indefinitely. Maybe you actually like those terms and there’s definitely some use cases where you like them. But that’s also a risk because it’s starting to turn into
Well, maybe I’m just making the interest payments and a lot of these use cases, dividends from the portfolio might be enough at the asset size, the clients we work with relative to the loans they take out might be enough to cover the interest payments. So it’s kind of out of sight, out of mind. If you don’t see it, you might forget about it and you’re actually increasing the total risk of your portfolio. I think there’s similar concerns with a HELOC, but a traditional loan
That’s fixed. That’s, we understand this is a five-year loan. This is a 30-year. This is a 15-year. We’re paying down principal with every single payment versus interest only. So there is that payback discipline that if you do choose to use a portfolio line of credit or a HELOC, you do want to make sure, we’re time constraining this or we are artificially building in some payback discipline. And how do we hold ourselves accountable to that payback discipline?
thing and this is our final section, this is number six. This is what’s the risk, right? This is what everybody should be thinking about. Hey, is this too good to be true? What are the potential downsides? One of the big downsides of a portfolio line of credit is you can only have so much of your portfolio out on margin. You can only borrow so much from it, which is fine when markets are going up, but there is a risk.
called capital call risk. There’s a risk that in many of these cases, you can have say 50 % sometimes depending on the actual products, it might be more, but 50 % of your portfolio can be out on loan as they would call it. What happens if your portfolio drops 50 %? Now the person that’s holding this collateral, it’s not worth the same. They’re gonna ask you to post more additional money. Well, when do you need more of this money?
Case Study 1: Helping a Child Buy a Home – A short-term need where avoiding capital gains can make a difference
Times are probably not good if the portfolio has fallen by 50%. So you really want to think about what is the likelihood of my particular portfolio falling? How much money am I attempting to temporarily generate from the portfolio and match those two so you don’t end up in a situation when times are bad, you really turn bad. If you kind of think about the famous real estate investors, look at how often
they go bankrupt. Why? Because they’re using a lot of leverage. And so we really, really want to be conscientious about making sure that there is ample room to protect against these these capital call risks. And this is also goes into how do you think about building your portfolio, right? This is another benefit of diversification of having a globally diversified stock portfolio, having some bonds in the portfolio is it’s going to take your range of outcomes and shrink it.
which gives you more confidence, more ability to utilize your portfolio in the future for situations like this, as compared to a highly concentrated portfolio of a few stocks, which have dramatically higher volatility than a diversified portfolio. All right, now that we walk through those six characteristics, let’s just walk through some different use cases. One of the most common use cases is helping to
deal with house purchases. Okay, so let me give the actual example. The actual example is a parent came to us and said, hey, I want to help my kids purchase a house. Now, when you come to us, the initial thought was, let’s sell securities. But you really have to dive a little bit deeper. Well, how long is it a forever purchase? Are you going to have the same approach with the rest of your kids?
And it turns out, hey, it’s actually going to be a temporary thing. Well, a temporary thing, you wouldn’t want to sell securities. We think that might have generated 10 or $15,000 of capital gains if it’s just going to be a six month or a year long time period until the mortgage comes through for the kids. And this kind of general trend is something we see quite often one of the major use cases, which is if you’re selling a house and buying another house, there’s a time period between
Those two events where you might not have the same amount of cash, right? You’re selling a house, you need the equity from that house to help you with the down payment for the next house you’re buying. There’s a mismatch. It’s a time constrained mismatch. This is a perfect tool for that, especially because the origination is super, super easy. It’s very efficient in terms of cost, right? Probably going to be a similar cost, ⁓ maybe a little bit more, but similar cost to the mortgage.
Case Study 2: Business Working Capital – Using a portfolio when traditional lending isn’t available or practical
definitely smaller than maybe a traditional loan. And there are certain products that are specifically designed for this. But one of the most important things is it is time constrained, right? You’re thinking about a small time period that’s going to limit your taxes. It’s going to reduce your risk of kind of this floating rate, interest rate phenomenon. And there is payback discipline because you kind of have this time constrained nature. So that’s one of the major use cases.
thinking about using this temporarily for help with down payments for houses. Another use case is for business owners. The specific case that we were dealing with is this business owner, a serial entrepreneur, so has a bunch of businesses, but this particular business didn’t have that much time period history, didn’t have that much credit history. So the problem that they were trying to solve for is there’s a mismatch between when their revenues come in,
and when their expenses go out. So they do a job, but it costs them money to do that job and they don’t get paid till the job is done. So there’s that working capital mismatch. If you don’t have credit history, it’s harder to go to a bank to get a specific loan like this. So the business owner can say, hey, I’m taking a risk already in operating this business, but I could put my personal securities up, use that to borrow money. The company can pay the interest rates.
on that money. So it definitely helps from an origination rate. ⁓ Cost is actually very favorable to some of the rates they would have gotten. This was a unique instance where I mentioned there’s three different types of portfolio lines of credit. You have securities back line of credit. You have margin. You have this pledged asset line. And one of the big differences, how much can you withdraw from the portfolio before you get asked to put up capital?
And there’s different rate differences. So in this case, you go with something that has a higher limit that you can withdraw to offer more protection, but that came with slightly higher costs. And this is a great example. Another use case, we often see this with similar situations is if your compensation is variable, right? Some years are just way better than other years. In the good years, you can have the confidence to invest into your portfolio.
If there’s a less favorable year, you can use these tools to pull money out of the portfolio. And you can kind of contrast that with another common tactic people might use for that scenario, which is a HELOC. Now, one of the downsides potentially of a HELOC is origination. There’s going to be hard credit pulls. There’s going to be applications. And there might also be one of the things we’re finding is there might also be fees if you’re not drawing down that HELOC. So if you’re not utilizing it, there’s definitely a cost to keeping it open.
as opposed to a margin type tool where, hey, you’re not using it, no harm, no foul, no cost there. So that is the second case. And that’s dealing with kind of business owners or highly variable compensated people. The last case is going to be funding a purchase, right? So, hey, I am going to buy a car. I’m going to buy a boat. I’m going to do a house addition.
Case Study 3: Funding a Major Purchase – Why flexibility can become a downside without a repayment plan
help me think through where is the most favorable rates. And this is some space where we often see the traditional loan, hey, just go get an auto loan, go get a boat loan, go get a loan specifically for this case. It might have more ⁓ legs to stand on despite probably being more expensive. Why might it be more beneficial? One of the big reasons is
probably the behavioral element to this thought that these loans, they’re going to be out there in perpetuity, right? And if your portfolio is large enough, the dividends might be covering the interest payments, which might lead you to kind of have an interest only loan in perpetuity, which creates future risks as opposed to having a disciplined repayment plan. Now there are kind of tactics that
You would say, I’m going to pay X amount every single month. I’m going to use this tool to the best ability. But I think this is just an important thing to have a real discussion around, a real conversation around to make sure that it’s going to fit with the intended use and it’s going to be used in a similar line as a traditional loan is going to be used. Also in this situation, think is really, if you go back to that capital call risk,
is thinking about how many eggs are we going to put in one basket? So the example is kind of, hey, in this case, the portfolio, we would have been withdrawing about 25 % of the portfolio. But the portfolio just happened to be in appreciated US stock positions. So you lose some diversification from bonds and non-US stocks, which just creates more of a potential.
for a drawdown that might trigger capital calls and just being conscientious of those two things. those are three use cases, six criteria to kind of think through those trade-offs, but hopefully everybody’s leaving this with two things. The first thing I would say is confidence to invest in your portfolio if your portfolio is set to the right risk.
Key Takeaways: Simplicity vs Flexibility – Why selling is often the answer and when borrowing makes sense
tolerance ⁓ because there are tools that you can choose to use that will help you create cashflow for the unexpected, right? As opposed to if you go back to our last episode on cash, we talked about this timeframe of, anything beyond two or three years, you don’t really know if it’s going to happen and you don’t really know when it’s going to happen. So you might be overly planning as opposed
to just investing in the portfolio. So that is one takeaway. And then the second takeaway, for as much as we talked about lines of credits and the potential benefits, I just remind everyone, selling securities from your portfolio oftentimes is the route that we advise people to proceed with or traditional loans. If they already have ⁓ a set purchase in mind, those are not
bad outcomes. Oftentimes, those are actually the most efficient outcomes because they reduce some of these risk factors, some of these variabilities that we walk through in the sixth criteria. So hopefully those two things were helpful for everyone and we will welcome Pat back in two weeks.
Sources
1 Securities Backed Line of Credit Explained (FINRA. 2024)
2 Know What Triggers a Margin Call (FINRA, 2023)
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