Securities Loan Trap

The financial services industry has a history of designing ways to tie up your money for years. Variable annuities are a classic example. Once you buy one, there are huge surrender fees for up to a decade. It doesn’t matter if the investment performance is horrible. You’re stuck.

Most people don’t realize that the securities loan their broker is offering them at an attractive interest rate does the same thing. It cements your relationship there, whether you like it or not.

How does this work? I’ll give you an example. James has a large taxable brokerage (non-IRA) account. He has millions of dollars’ worth of investments, but he would have to realized gains and pay taxes to withdraw it. So when James decides to buy an investment property, his broker offers him an alternative. James can take a loan against his securities and not have to sell anything. That sounds good to James.

Fast forward to a few years down the road. James realizes his broker is a slick salesperson, but doesn’t actually know much about wealth management. James meets a fee only registered investment advisor (RIA) he wants to hire instead. When it comes time to move his investments to the new advisor, James realizes that he would have to pay off his securities loan first.

James starts to pay more attention to this loan and realizes it has two more negatives. The interest rate is variable (going up these days) and it’s an interest only loan. James’ loan is actually bigger now than when he took it out. At that point James, who still doesn’t want to pay taxes on selling his investments, decides his broker really isn’t that bad. He settles and stays there. I’ve seen it happen. Don’t let it happen to you.

Legal Disclaimer: These posts do not constitute an offer or recommendation to buy or sell any securities or instruments or to participate in any particular investment or trading strategy. They are for informational purposes only. CTW gathers its data from sources it considers reliable. However, CTW makes no express or implied warranties regarding the accuracy of this information or any opinions expressed by the author and may update or change them without prior notification.