Have you been borrowing to invest? Or borrowing against your brokerage account to pay your bills? Are you crazy or what?
In this past week, I've spoken to:
? A TV technician who's been using his brokerage account as a piggy bank. He has borrowed against one-third of it, to buy a car and help pay his bills.
? A wealthy investor who keeps an aggressive stock account, and "forgot" to tell his financial adviser that he'd used it as collateral for a $400,000 loan. He put the money into two Russian funds (diversification!), bought through another adviser.
? A computer programmer, who borrowed against her house to invest in brokerage-house mutual funds.
The TV technician is sweating out this market drop. If his stocks fall too far, he'll get a margin call meaning that his broker will ask him to cover part of his loan with cash. He doesn't have the cash. In that case, his broker would sell some of his securities, at a loss, and use the proceeds to lower the debt.
The wealthy investor has gotten a margin call already. His aggressive stock portfolio was bombed this year, so he's losing his Russian funds and a lot of his stock positions, too. His original (sane and sober) adviser was planning to sell some of his underwater stocks, book the tax loss and use the proceeds to buy more promising securities.
Too bad. This investor is taking the loss, all right, but losing out on the potential gain.
The computer programmer is underwater, too. She's paying 9.5 percent on her home equity loan (6.8 percent after tax), and paid her broker a commission of 4.5 percent. So she needed a gain of 11.3 percent this year, just to break even. She needed a super gain of 16.36 percent just to net the 5.06 percent she could have gotten from a U.S. Savings Bond.
In the second year (with no further sales commission to pay), she'll need a gain of 11.86 percent to beat U.S. Savings Bonds, if interest rates remain the same.
What were these investors thinking of?
When you're young and trying to build up savings for the future, you shouldn't pillage your investments to pay your bills. It's tempting, when your stocks soar. You can take out some money and still feel rich.
Your monthly statement may show you how much you can borrow just for the asking at an interest rate of maybe 9.25 percent.
The TV technician's stockbroker saved him some grief. You're generally allowed to borrow up to 50 percent of the value of your better-quality equities (stocks listed on an exchange, well-diversified mutual funds and some over-the-counter stocks). Left alone, the technician told me, he would have done it.
But his broker strongly advised against it. You normally don't get a margin call unless your securities, minus the debt, are worth 30 percent or less of their nominal market value. In a plunging market, accounts with big loans are more vulnerable than accounts with small ones. So far, the broker has kept the account afloat.
The wealthy trader was going for broke and almost made it. He knew Russian stocks and bonds carried phenomenal risk, but saw the huge returns in the market early this year and figured he'd get out in time. Dream on.
On a smaller scale, ordinary investors play the same kinds of fantasy games with options, small stocks culled from Internet tipsters or foreign-currency bets. If you want to swing for the fences, that's your lookout. But do it with "hobby" money, not money you're really going to need.
The computer programmer said she never stopped to think what she'd have to net, to cover her borrowing and investment costs. She was lured by the pretty picture: Tax-deduct your loan interest while making sure-fire money on stocks. Gains of 20-plus percent have come to seem so commonplace that she assumed she'd easily come out ahead.
Luckily, she isn't risking a margin call. But she faces years of payments on her home-equity loan, and needs a blazing stock market just to cover her costs. When she'll start making some money is anybody's guess.
Borrowing against your securities isn't always wrong. But here's what it takes to make a success of it: a savvy investor, using the proceeds to reinvest, who has calculated the cost of the loan against the potential gain, and has the stomach to cut losses fast, before they compound. If that's not you, leave your securities account alone.
A reader in Boynton Beach, Fla., writes that he switched long-term care policies, from one insurer to another, because the new one seemed to offer better benefits. Then he learned that his old policy had special tax benefits that his new one lacked.
"That was never mentioned in my discussion with the insurance rep," he grouses. So, here's what an agent should disclose:
Long-term care policies with tax benefits are called "qualified." Those without are "nonqualified." Some insurance reps argue that the nonqualified LTC coverage is a better deal. The majority, however, come down on the other side.
A qualified policy offers you two federal tax breaks:
1) You might be able to write off part or all of the premium you pay. The deductible amount depends on your age. It ranges from $210 for buyers 40 or less, to $2,570 if you're 71 and up.
This write-off doesn't amount to much. To get it, you have to itemize on your tax returns. Also, it's counted as part of your personal medical expenses, deductible only to the extent they exceed 7.5 percent of your adjusted gross income. Not many taxpayers qualify.
If you're self-employed, you can write off 45 percent of the premium this year (and more in later years), as a business expense.
2) If you collect benefits, they're guaranteed free of federal tax.
All LTC policies sold prior to Jan. 1, 1997 are considered qualified. Policies sold since that date are qualified only if they meet certain criteria.
A nonqualified policy, by contrast, offers no tax deductions for the premiums you pay. For most people, that's a minor item. The major item is the tax status of any benefits you receive.
Some insurance agents will tell you that nonqualified policies also pay benefits tax-free. But they're blowing hot air. The IRS says that it hasn't ruled on this question yet.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
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