Whether you are interested in growing your wealth or protecting it, the strategic use of credit can help you achieve your goals. And with interest rates trending lower, now could be an opportunistic time to consider the borrowing tools at your disposal. However, as with any major financial decision, there is always more to the equation when deciding if borrowing is right for you.
Other important considerations include liquidity, investment needs and tax management. If you are planning to use credit to participate in market opportunities, the anticipated return and holding period of the investment, as well as your capacity to repay the debt, can lead to more nuanced decision-making. But before diving into personal factors, it’s worth exploring the economic environment and how it could influence your decision.
When Covid-19 and its related lockdowns disrupted economies around the world, the Federal Reserve (the Fed), like many central banks, deployed looser monetary policy to incentivize consumers to continue participating in the real economy. In conjunction with stimulus packages and other fiscal measures, this helped keep the U.S. economy afloat. But at what cost?
To tame inflation, which had reached 9.1% in June 2022,¹ the Fed commenced a series of rate hikes that saw its key rate climb to a target range of 4.25% - 4.50% by the end of that same year. By mid-2023, the fed funds rate entered a range of 5.25% - 5.50%, pulling interest rates into multi-decade highs.² However, after gradually slowing, inflation is more manageable today, and key economic indicators have given the Fed enough confidence to begin its long-awaited rate cutting campaign.³
As the pendulum swings toward more favorable rates, borrowing will become more attractive. And that’s not the only opportunity arising from the shifting economic landscape. Investment returns may potentially benefit too.
For example, the stock market generally has an inverse relationship with interest rates and performs better in lower rate environments. In addition, markets historically rally following presidential elections, further making the case for borrowing. This is because leverage can be deployed strategically to increase market participation when tailwinds are transpiring in the backdrop.
These factors make it easier to achieve positive arbitrage, which is when you borrow to purchase investments and the rate at which you borrow is lower than the investment’s return over time. When used correctly, this can be considered a strategic use of leverage, which ultimately helps support your wealth goals.
Certain reasons one may use leverage are more dependent on personal catalysts than interest rates. They can result from the desire to create liquidity for market opportunities, short-term needs or unexpected expenses, whereas selling investments for the same purposes would lead to negative tax repercussions. In these cases, it may be more important to evaluate your long-term outlook versus short-term gains, as well as your time horizon and the opportunity cost of borrowing.
For example, when a short-term expense is due, such as a tax bill, your first instinct may be to sell investments in order to create liquidity. Aside from taking money out of the market and missing out on long-term asset appreciation, this can lead to increased capital gains tax. But a more prudent approach could be to borrow against your liquid assets with an investment credit line and use the proceeds to pay the bill. Not only would you be able to meet the expense, but it would provide access to funds for new investment ventures. This way you can keep your tax bills low, continue to benefit from the long-term appreciation of your invested assets, and you can increase your overall net worth with the additional investments made using the proceeds.
Another example of strategic borrowing is to utilize a cash-out refinance mortgage to access the equity in your home. Reasons you may want to do this include funding major expenses, purchasing another property, raising capital for your business or even paying down floating rate debt.
And, of course, traditional uses for mortgages, like helping family members purchase their first home, still qualify as valid reasons to consider borrowing. But remember, everyone is unique and there is no one-size-fits-all solution.
Some needs may require sophisticated, customizable lending solutions. Without going into too much detail, any of the below are worth exploring if you believe they speak to your specific situation. For example…
1) You may wish to use your art collection to unlock more liquidity.
If you’re an art enthusiast, a portion of your net worth may be locked up in illiquid masterpieces from well-known artists or next big things from contemporary icons. Whatever the case may be, you don’t have to sell your beloved art. With fine art financing, eligible pieces can be used as collateral to secure a loan, allowing you to keep your art in your possession. This newfound liquidity can help bring long-term goals to fruition while keeping your investments intact. It can also help service debt through existing cash-flow capabilities.
2) You might be considering the purchase of a new private jet and you want to leverage the value of your existing one.
When your current jet is no longer cutting it, you may be looking for a faster, more luxurious aircraft to call your own. This can be pretty costly, but rather than liquidate investments that are still growing, you can partner with BNY and tap into its aircraft financing capabilities to achieve your goal. Not only does this allow you to make the purchase, but you get to participate in an enhanced investment strategy.
3) You may want to take a multi-dimensional approach with your wealth transfer strategy.
When a certain level of wealth is achieved, it can be wise to think of your balance sheet like a company or institution. This means having a healthy balance of assets and liabilities, which is especially important when seeking a tax-efficient wealth transfer to the next generation. Trust and estate beneficiaries can benefit from a better balance between leverage and marketable securities, allowing them to reduce exposure to assets that are subject to capital gains tax. This is where structured lending solutions for trust and estates can help.
That said, it’s important to remember that these highly individualized strategies are often complex and should be explored in coordination with an experienced wealth manager.
Some situations may call for deleveraging your balance sheet. If you have a high level of leverage and/or you are unable to generate sufficient, recurring cash flow to meet obligations, it may be better to liquidate assets instead of taking on additional debt. This can help improve financial stability and flexibility. By ensuring all assets are not leveraged, the ability to liquidate and reduce overall debt remains an option, whether it be prompted by excessive debt service obligations or a decline in asset values.
The decision to increase or reduce leverage should be based on a careful analysis of your financial circumstances as well as the potential risks and benefits of each option.
In light of the evolving interest rate environment, now is the time to consider your borrowing needs, current debt levels and time horizon. These will be the biggest determining factors in deciding if you should consider lending solutions as part of your overall wealth strategy.
As always, you should work closely with your advisor to determine the highest and best use of any free cash flow, weighing the potential benefits of borrowing to invest against paying down on pre-existing debt. This could also mean doing both with any free dollars in blended investment and amortizing strategy. Regardless of which strategy you choose, borrowing can help achieve both short and long-term wealth goals.
¹ The Wall Street Journal: U.S. Inflation Hits New Four-Decade High of 9.1%. July 13, 2022.
² Forbes: Federal Funds Rate history 1990 to 2024. September 18, 2024.
³ CNN: Key takeaways from the Fed’s decision to deliver a jumbo-sized interest rate cut. September 18, 2024.
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