The Unanticipated Costs of Illiquidity and How a Securities-based Line of Credit Can Help
Investing is a constant pursuit of balance and strategy—a tug-of-war between liquidity and growth potential. As someone who’s accumulated a significant amount of wealth, you’re likely already familiar with this challenge.
While cash and cash equivalents have their place in every investor’s portfolio, too much liquidity means missing out on future investment or business opportunities. In the worst-case scenario, it may require you to disrupt other areas of your portfolio, accrue high-interest debt, or put certain life decisions and actions on hold.
In other words, illiquidity can come with some hidden costs, which have the potential to be more than financial—they can impact your lifestyle, reputation, and strategic opportunities. For those reasons, balancing your portfolio’s liquidity and illiquidity levels is key to mitigating these risks. A securities-based line of credit may be able to help.
3 Challenges with Illiquidity for Wealthy Individuals
Having a substantial amount of assets can help you achieve your and your family’s greater goals—hitting every destination on your bucket list, sending your kid off to college debt-free, starting a new business venture, you name it.
But there’s another half to the equation, and that lies in your ability to convert those assets into cash in a timely manner (i.e. how liquid your assets may be).
When too much of your portfolio is tied into illiquid assets, you may experience certain challenges including:
Missed opportunities: Certain investment opportunities will often require immediate capital—and depending on the specifics, a substantial amount of it. This is particularly true for those investing in alternatives or private equity. If you’re unable to access liquid assets within the time period needed to participate in the investment, you may miss out on potential earnings.
Forced asset sales: When a portion of your portfolio is dedicated to liquidity, it enables you to preserve the other aspects of your portfolio—allowing them to continue compounding, growing, and recovering from market fluctuations (should a downturn occur).
If you don’t have enough liquidity within your portfolio, you may be forced to sell investments or property under pressure—meaning you may be selling during a period of market volatility or otherwise poor market conditions. Doing so can impact the sale price and, potentially, the long-term performance of your portfolio.
Lifestyle Constraints: Issues with illiquidity could impact your ability to maintain a desired lifestyle or reputation when unexpected cash flow needs arise. For affluent individuals and families, this constraint can ripple into personal and professional networks.
What is a Securities-Based Line of Credit?
Rather than sell your illiquid assets outright to increase liquidity within your portfolio, there is another way to preserve your assets and still gain access to cash when needed.
This is called a securities-based line of credit, it involves securing a flexible, pre-approved line of credit backed by your existing investment portfolio assets. Unlike a personal loan, which can take quite some time to acquire and come with unfavorable terms, securities-based borrowing enables you to access liquidity almost instantly without disrupting your long-term investment strategy.
The Benefits of Securities-based Borrowing
Beyond providing access to cash, this strategy offers a few notable benefits.
Portfolio Preservation
Investors who opt to leverage credit may be able to avoid the long-term ramifications of selling assets during unfavorable market conditions. Because this line of credit is backed by securities, you can more effectively leverage your portfolio while still keeping it intact. This gives your existing investments the opportunity to continue participating in market growth opportunities, as intended.
Flexibility
When you have securities-based line of credit already integrated into your financial landscape, it becomes easier to act decisively and move quickly as needed to participate in investment opportunities or exciting life events. This can, of course, help you accomplish your goals sooner or participate in investment opportunities that may otherwise be challenging to access.
Cost Efficiency
Cost efficiency is an important factor to consider anytime borrowing is involved. Because securities-based borrowing leverages existing collateral, lenders may have more leverage to provide lower interest rates (as compared to unsecured loans or other higher-cost financing options). Depending on your portfolio, market conditions, and other factors, the cost of accessing liquidity through a securities-based line of credit may better align with your needs than selling off or withdrawing from other parts of your portfolio.
How a Securities-based Line of Credit Looks in the Real World
Let’s say you’re looking to relocate to Florida (who could blame you!), and you need liquidity now to purchase property, renovate the home, and cover all buying costs and moving expenses. A securities-based line of credit can help you access funds and secure that prime real estate spot without going through the delays and headaches associated with traditional mortgages and financing.
There’s also some extra peace of mind knowing your inevitable unexpected expenses are going to be covered—again without disrupting your long-term investment strategy. Other common uses include:
Tax payments
Real estate financing
Debt consolidation
Education expenses
Business financing
Luxury purchases, such as a boat, jewelry, or fine art
Balancing Opportunity and Growth Within Your Portfolio
The team at Edwards Asset Management is equipped to support the complex liquidity needs of Florida’s affluent investors and their families.
If you’re considering making Florida your permanent residence, our team can help you navigate important decisions about transitioning to the Sunshine State—including whether a securities-based line of credit is right for you.
Interested in Learning More?
Illiquidity doesn’t have to hinder your financial goals. With a securities-based line of credit, you can preserve your wealth, capitalize on opportunities, and maintain the lifestyle you’ve worked hard to build.
Our team is happy to work with your other trusted professionals and agents to deliver comprehensive solutions and sophisticated, tailored wealth strategies. To learn more, request an introductory conversation to see if our team and services is a good fit for you and your needs.
Rob Edwards is a Managing Director and Senior PIM® Portfolio Manager at Edwards Asset Management. Rob is a nationally recognized advisor who helps millionaire families navigate the complexities of their wealth. Edwards Asset Management has offices in Naples, Florida and Fort Lauderdale, Florida.
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.
Wells Fargo Advisors Financial Network does not provide legal or tax advice. Be sure to consult your own tax advisor and investment professional before taking any action that may involve tax consequences.
Lending and other banking services available through Wells Fargo Advisors (NMLS UI 2234) are offered by banking and non-banking subsidiaries of Wells Fargo & Company, including, but not limited to Wells Fargo Bank, N.A. (NMLSR ID 399801) and Wells Fargo Home Mortgage, a division of Wells Fargo Bank, N.A. Certain restrictions apply. Programs, rates, terms, and conditions are subject to change without advance notice. Products are not available in all states. Wells Fargo Advisors is licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act and the Arizona Department of Financial Institutions (NMLS ID 0906158). Wells Fargo Clearing Services, LLC, holds a residential mortgage broker license in Georgia and is licensed as a residential mortgage broker (license number MB2234) in Massachusetts.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC. Edwards Asset Management is a separate entity from WFAFN.
