To HELOC, or not to HELOC?

Are you saying that you can take cash out of a margin account? I was unaware that this was possible, though I guess I shouldn't be surprised.

-Will

Oh, sure. If you have, say, $100,000 in a brokerage account (with a margin agreement) and invest every penny in stocks, you can write a check for up to half that value (though that may put you right at the edge of a margin call. It varies somewhat and depends on the securities and the brokerage, of course). You'd pay interest on that $50k at a pretty hefty rate (margin rates go way down when you borrow, say, a million bucks, but rates for small margin loans are pretty harsh. At E*Trade, for example, the current rate on a margin balance of $50k or less is 10.24%).

Now, if you have $100,000 in assets in a margin account, your *buying* power is more substantial than your cash withdrawal power, since if you buy more marginable assets inside the account, you can borrow against those, too. With that same, $100k, you could buy another $100k of ordinary equities.

In both cases - withdrawing cash or buying more securities, you end up at 2:1 -- in one case, you started with $100k equity, extracted $50k cash, leaving $50k equity invested in $100k of securities. In the other case, you started with $100k equity invested in $100k of securities and bought another $100k of securities - so you end up with $100k of equity in a $200k portfolio. In both cases, you've borrowed money and pay interest (to your brokerage) on it.

Note, too, that the amount of leverage possible depends on the securities in question. They'll typically let you borrow a lot more against, say, treasury bonds than against equities for example.

Frankly, I can't see much use in folks borrowing at prime+3% to buy equities, though I guess I can see using it very short-term for cash management purposes (ie. maintain one's positions when one knows that some new cash is coming in *very* soon).

Note that a margin agreement potentially puts your positions at risk - if your positions go down in value substantially and you've got a big loan against them, your brokerage may issue a "margin call" - requiring you put put up some cash right now or sell some securities. Your brokerage may even just go and sell of one or more of your positions themselves to meet that margin call, though they typically give the investor a few days to deal with it before they'll do that.

Will, it seems odd to me to go through the trouble of giving yourself the ability to borrow a bunch more money, and take on some costs to do so, if there's little chance you'll actually need to borrow. If you do get to that point, you'd have what - two years to make other arrangements - including getting a HELOC then? It's like buying up canned goods in June in case a blizzard hits. I don't see home-equity-basd credit going away anytime soon, if anything I expect a big expansion in ways to borrow.

Also, you've probably been able to observe it but I wonder if all those $25-bonus new credit cards you're collecting could end up dinging your FICO score -- resulting in higher borrowing costs, i.e. more financial pressure, should the need to borrow arise. In my gut there seems to be an asymmetrical analysis of the risks here. On one hand, opening a HELOC in case Doomsday hits (2+ years of zero income). On the other, grabbing $25 bonuses even though they might make that HELOC borrowing rate substantially more expensive, because you're judged to be a worse credit risk as a result. Maybe knock it with the new cards and count on opening a HELOC should the need arise?

Another issue here...IIRC you're a regular saver, based on prior posts...are you perhaps saving too much of that via qualified accounts? If you're building a non-qualified piece alongside the 401k/IRA/etc these kinds of concerns go away, gradually. I don't think it's wise to keep everything on the qualified side with little/no growth of accessible investments and that may be part of this question too.

-Tad

My concern with this is that if he's in the middle of two years of unemployment, etc, then he may well *not* be able to get that HELOC just when he needs it. HELOCs will still exist, and his home equity will likely be intact, but will he qualify?

That said, with two years of living expenses in accessible investments and cash, the chance that he'll need to hit that HELOC is pretty slim.

Definitely a valid concern - but he could avoid that by opening the HELOC the day he gets his notice at work, right? It could be a good thing to put on the "about to lose job" checklist, but now?

Though one thing Will mentioned is that their income is variable and if it's extremely so, the HELOC might be a good idea, period. I've had a few clients who freelanced, or did consulting, or ran a startup business, and they're always in that mode of not knowing if there's going to be any income coming in during the next year. One who owns a house does have a HELOC. Those whose compensation is bonus-driven typically earn enough from their base to cover costs, or have enough saved up in accessible places, or both.

-Tad

Dammit, Tad, the pro-HELOC folks had me won over, now you're making me rethink this again. The above statement is exactly the argument I used with my wife.

It's not clear to me that cards with no balance make a significant difference in your FICO score. Do they? See for example this dude with

80 cards and a score of 794:

I haven't thought about this. It seems odd that one could save too much in qualified accounts. My retirement funds have a little over 16% in taxable investments, with the rest in qualified accounts (I'm not counting liquid emergency buffer in this).

-Will

But this is not literally possible or wise, is it? First, it wouldn't give me time to shop for a good deal. Second, the HELOC source I choose may not contact my employer for employment verification that very day, besides which, in my industry a layoff usually comes without warning (to an individual, typically you'll know that somebody is getting booted) and results in the affected persons getting escorted out of the building.

My wife's income is extremely variable, mine is steady. However, a layoff in a bad year for my wife and we'd be in deep kimchee.

-Will

Will - there are two possible outcomes to an argument with one's wife, either she wins, or you lose. The financial decision to be made seems to boil down to X$, something like $25/yr and maybe a closing fee, compared to a rift between you two or your wife's discomfort. Here, we frequently talk about stock/bond mix being shifted according to someone's 'sleep factor' (I believe 'sleep number is a registered trademark for a mattress manufacturer), in your case, this dialog is really about very little money, and all relationship jokes aside, it's cheap insurance.

We spend nearly $2K/yr in term life premium, $3K home insurance, $2500 for cars, $7500/yr total for events we hope will never occur. $25 or $50/yr is nothing compared to the risk the extra line may one day help you avoid.

Just my (final) two cents, JOE

There have been some good comments on this. My own is somewhat different in that my preference would be to set aside now whatever cash level is desired in a liquid account.

I appreciate that the number crunchers among us frown on keeping large amounts "unproductive", but I would counter that it is very productive

- it makes us sleep better but more importantly it ensures that our long-term investments, together with regular contributions thereto, can remain undisturbed. After all, I think it is that steady-as-you-go savings over time that makes everything work.

But most of all I do not see additional debt (HELOC, credit cards or whatever) as a problem solver - especially during periods where financial stress already exists.

-HW "Skip" Weldon Columbia, SC

If your goal is to avoid debt, then the above is excellent advice. If your goal is to reduce the cost of risk, then it may not be.

As I see it, you have three ways of handling a financial emergency:

1) Keep cash in liquid reserve (idle.) 2) Keep a credit line open. 3) Be prepared to sell investments at a loss.

Each way has a cost associated with it and in every case, the cost depends on future unknowns (i.e., the timing and nature of the emergency.) Because of these unknowns, the best choice IMHO is to diversify... do all three.

I think option (1) above is best for those little emergencies that continually come up. Option (2) is best for middling emergencies that you know you can recover from quickly and option (3) is for the rare big emergency that will take some time to recover from (if ever.)

I'm just getting started in all this, so I would love some feedback on this opinion. How close am I?

Keeping cash in liquid reserve is poorly defined as being "idle". Money Market funds are currently paying over 5% and short-term bond funds approximately the same. I don't track T-Bills and such, but think you could bring those home in the same neighborhood. True, that's higher than in the recent past, and not as much as you'd currently earn in equities. Still, it's not idle by almost any definition. I would define "idle" as monies deposited in accounts that pay interest, if at all, below the rate of inflation.

Elizabeth Richardson

I think you are spot on. Take care to keep the cost of the credit line low (not credit cards if you can help it).

Selling losing investments will help with your taxes that year as well if they are in taxable accounts.

You should not sell investments in tax deferred accounts except in extreme emergencies.

-- Doug

Granted. However, I expect that money in a liquid reserve is going to earn less than money locked up in some long term investment. So there is an opportunity cost and that is the point.