Whether you’re getting a loan or cashing out, here’s what to consider during market volatility and rising interest rates.
Making smart cash flow choices for your financial life isn’t always straightforward, especially in times of market uncertainty.
One fundamental way to make financial decisions easier is to look at the potential cost versus benefit. For example, are you facing a large expense, such as a large tax bill, a residential or commercial real estate transaction, or something else? Now is the time to consider the impacts of borrowing versus liquidating assets to cover those costs.
Even when interest rates are rising, both approaches can be worth considering. Borrowing may provide the opportunity to handle an emergency or make a major purchase at a discount without disrupting a portfolio.
“Just having quick access to capital or a line of credit can be important at this time,” says Jessica Kelly, a brokerage lending consulting director for Wells Fargo Wealth & Investment Management.
With that in mind, here are some cash flow considerations during market instability and rising interest rates.
Borrowing versus liquidating assets
When faced with cash flow needs, individuals should explore all the lending options available to them, says Trisha Knake, head of securities-based lending with Wells Fargo Wealth & Investment Management. Both Kelly and Knake agree that borrowing to pay off a tax bill, for example, could be a better option than selling assets to cover the expense, particularly if the sale would mean sacrificing potential earnings plus creating a capital gains tax expense.
“Sometimes it is correct to liquidate or use cash depending on your situation,” Kelly says. “But if you have a portfolio investment with an 8% rate of return and you can borrow money at 5.75% short-term, that could work to your advantage. Many clients we see are not borrowing long-term anyway, so that could make sense for them.”
When it comes to borrowing, harnessing the value of your investment account could be worth considering. Securities-based lending (SBL) is an option that uses securities such as stocks, bonds, and mutual funds as collateral, and it could help you meet your liquidity needs.
“A securities-based credit line typically comes at a more attractive interest rate than an unsecured loan or a loan against less liquid collateral,” Knake explains.
Kelly agrees. “SBL rates tend to be lower than other variable rate credit lines, plus there isn’t a credit check or an underwriting process.”
Knake and Kelly describe these potential advantages of securities-based borrowing:
- Quick access to cash while potentially avoiding capital gains taxes from selling securities
- Typically lower rates compared to other forms of borrowing such as credit cards
- No set-up, non-use, or cancellation fees
- Ability to borrow up to 50% to 95% of your eligible asset value, depending on the collateral type
But SBLs do have some risks. “One downside is the risk of a margin call,” Knake says. (A margin call is issued when the value of the collateral falls below the amount required by the lender to support the loan.)
“It could cost you more in the long run, and there could be negative tax ramifications,” Kelly says.
It can help to put yourself in a chief financial officer (CFO) mindset when determining how to achieve your goals while managing your cash flow.
Paying cash to cover expenses
In some instances, it can make sense to pay cash instead of borrowing. “If someone has a fair amount of cash and is not planning to invest that cash, that could be the better solution to pay for things, including a car, a house, a child’s education, expansion of a business,” says Knake. “It’s not a one-size-fits-all, so it’s important to work with an advisor to review an individual’s assets versus their liability in order to determine if paying cash makes the most sense.”
Other reasons to use cash include not having access to enough credit or simply being debt-averse. Using cash reserves instead of selling securities to gain liquidity could also make sense because cash has low long-term growth potential compared to securities.
Think of assets and liabilities like a CFO
It can help to put yourself in a chief financial officer (CFO) mindset when determining how to achieve your goals while managing your cash flow. For example, CFOs typically take a holistic balance sheet approach that includes account assets (equities) and liabilities (borrowing).
“If you look at most corporations, they’re comfortable with a certain amount of leverage (borrowed capital) to optimize their balance sheets,” Knake says. “And many of our high-net-worth and ultra-high-net-worth clients could look at their overall balance sheet to see how they can optimize it by reviewing both assets and liabilities together. That can mean comparing the cost of borrowing versus the cost of liquidating or staying invested, and making decisions based on that comparison.”
Regardless of what individuals decide to do next, Knake and Kelly say they should carefully review all of their options with a wealth advisor.
“Individuals have dreams, hopes, and goals, and there are ways to fund them even during times of market uncertainty,” Kelly says. “You just have to decide the best option for you, which can be made clearer by having those conversations with your advisors.”
Wells Fargo Wealth & Investment Management (WIM) is a division within Wells Fargo & Company. WIM provides financial products and services through various bank and brokerage affiliates of Wells Fargo & Company.
Securities-based lending has special risks and is not appropriate for everyone. If the market value of a client’s pledged securities declines below required levels, the client may be required to pay down his or her line of credit or pledge additional eligible securities in order to maintain it, or the lender may require the sale of some or all of the client’s securities. Wells Fargo Advisors will attempt to notify clients of maintenance calls but is not required to do so. Clients are not entitled to choose which securities in their accounts are sold. The sale of their securities may cause clients to suffer adverse tax consequences. Clients should discuss the tax implications of pledging securities as collateral with their tax advisors. An increase in interest rates will affect the overall cost of borrowing. All securities and accounts are subject to eligibility requirements. Clients should read all lines of credit documents carefully. The proceeds from securities-based lines of credit may not be used to purchase additional securities, pay down margin, or for insurance products offered by Wells Fargo affiliates. Securities held in a retirement account cannot be used as collateral to obtain a loan. Securities purchased in the pledge account must meet collateral eligibility requirements.
Wells Fargo Advisors (“WFA”) and its Financial Advisors have a financial incentive to recommend the use of securities-based lending products (“SBLs”) rather than the sale of securities to meet client liquidity needs. Financial Advisors will receive compensation on Priority Credit Line (“PCL”) and other non-purpose SBL from Wells Fargo Bank. Your Financial Advisor’s compensation is based on the outstanding debit balance in your account. In addition, your Financial Advisor’s compensation will be reduced if your interest rate is discounted below a certain level. This creates an incentive for Financial Advisors to recommend PCL and other SBL products, as well as an incentive to encourage you to maintain a larger debit balance and to discourage interest rate discounts below a certain level. The interest you pay for the loan is separate from, and in addition to, other fees you may pay related to the investments used to secure the loan; such as ongoing investment advisory fees (wrap fees) and fees for investments such as mutual funds and ETFs, for which WFA and/or our affiliates receive administrative or management fees or other compensation. Specifically, WFA benefits if you draw down on your loan to meet liquidity needs rather than sell securities or other investments, which would reduce our compensation. When assets are liquidated pursuant to a house call or demands for repayment, WFA and your Financial Advisor also will benefit if assets that do not have ongoing fees (such as securities in brokerage accounts) are liquidated prior to, or instead of, assets that provide additional fees or revenues to us (such as assets in an investment advisory account). Further, different types of securities have higher release rates than others, which can create a financial incentive for your Financial Advisor to recommend products, or manage the account, in order to maximize the amount of the loan.
Return figures and rates mentioned are shown for illustrative purposes only and do not reflect any actual returns or rates available through Wells Fargo.