5 ms·

What about the interest accruing on the debt? I didn’t see that accounted for.

by cannaceo 5y ago

WalterBright 5y ago
If you're paying 8% interest on the debt (Etrade charges a bit less than 8%) that can get out of hand quickly.
- robotresearcher 5y ago
  That’s less than half the capital gains tax rate. You’d still come out ahead.
  - cudgy 5y ago
    Not necessarily…capital gains tax is only paid once while interest must be paid continuously.
    - robotresearcher 5y ago
      To live on these gains you’d need to sell periodically. And the taxes you didn’t pay are compounding in your investments to more than pay the interest rate forever.
modeless 5y ago
Don't forget that you get to keep your money invested, which means it keeps appreciating. As long as your investments outperform the interest rate, you come out ahead no matter how long you hold the loan. If you borrow at 3% and have the same amount of money invested and earning 10% nominal returns as the S&P 500 tends to do, you're still ahead 7% a year and can hold the loan forever without losing money. The biggest issue is if you keep taking loans every year, you might become over leveraged. Then if the market crashes you'll get margin called and lose everything. So this only works if your net worth is much higher than your annual spend, so your loans never reach more than around 30% of your net worth within your lifetime. The other issue of course is that there's no guarantee your investments will be able to outperform the interest rate, especially as it will almost certainly be a variable rate. But ignoring short term fluctuations, I think it's pretty unlikely that this would be a big problem over the long term.
cornel_io 5y ago
Interest rates are almost zero right now (AFR is 0.12% for short term in July), so money is "free" if you're a low enough credit risk, and fully collateralized loans are easy to get at near-AFR rates if you're rich. I'm not so sure people are doing this to avoid taxes, though, as opposed to truly wanting to remain in the market as much as possible. If I was Bezos and I had faith in Amazon, I wouldn't want to exit any of my position, especially since that can send a negative signal to the market, etc. If I could hold my position and still spend money without racking up nearly any meaningful interest, I'd happily do so, you'd kinda have to be crazy not to since there's no downside (the principal keeps on earning for you and there's very little cost to service the debt). Companies do stuff like this all the time, there are a million good reasons to maintain debt even when you have assets you could otherwise liquidate, especially when rates are low. Besides, unless it's given away to charity the bulk of the wealth will be taxed at death anyways via estate tax, so I'm not entirely following the nefarious implications here. I guess people are mad that the borrowed and spent money effectively escapes taxes since it's paid by the estate pre-estate-tax, I guess? I'm reasonably sure that no bank would loan someone in this situation anywhere near their entire net worth, so I can't help but feel like this is a very edge-casey small issue that is only a problem in the rare years where interest rates are so low that it makes sense to do this...
- novok 5y ago
  So what kind of rich do you have to be to get near AFR loans. Cheapest I've seen is IBKR right now at %1.6 with a margin loan.
  - cornel_io 5y ago
    Eh, I guess that's not super accurate, no bank will loan at AFR, you're correct. But an LLC with cash in the bank that you control or owes you a favor can and will, and that's completely on the level as long as you pay AFR rates.
  - MattGaiser 5y ago
    Scroll further down on the IBKR table. 1.6% is the rate everyone gets. If you manage 200 million for example, you pay 0.75%. Some other currencies have 0.5% interest. https://www.interactivebrokers.com/en/index.php?f=46376 https://www.interactivebrokers.com/en/index.php?f=46376

What about the interest accruing on the debt? I didn’t see that accounted for.

WalterBright 5y ago

If you're paying 8% interest on the debt (Etrade charges a bit less than 8%) that can get out of hand quickly.

robotresearcher 5y ago
That’s less than half the capital gains tax rate. You’d still come out ahead.
- cudgy 5y ago
  Not necessarily…capital gains tax is only paid once while interest must be paid continuously.
  - robotresearcher 5y ago
    To live on these gains you’d need to sell periodically. And the taxes you didn’t pay are compounding in your investments to more than pay the interest rate forever.

modeless 5y ago

Don't forget that you get to keep your money invested, which means it keeps appreciating. As long as your investments outperform the interest rate, you come out ahead no matter how long you hold the loan. If you borrow at 3% and have the same amount of money invested and earning 10% nominal returns as the S&P 500 tends to do, you're still ahead 7% a year and can hold the loan forever without losing money. The biggest issue is if you keep taking loans every year, you might become over leveraged. Then if the market crashes you'll get margin called and lose everything. So this only works if your net worth is much higher than your annual spend, so your loans never reach more than around 30% of your net worth within your lifetime. The other issue of course is that there's no guarantee your investments will be able to outperform the interest rate, especially as it will almost certainly be a variable rate. But ignoring short term fluctuations, I think it's pretty unlikely that this would be a big problem over the long term.

cornel_io 5y ago

Interest rates are almost zero right now (AFR is 0.12% for short term in July), so money is "free" if you're a low enough credit risk, and fully collateralized loans are easy to get at near-AFR rates if you're rich. I'm not so sure people are doing this to avoid taxes, though, as opposed to truly wanting to remain in the market as much as possible. If I was Bezos and I had faith in Amazon, I wouldn't want to exit any of my position, especially since that can send a negative signal to the market, etc. If I could hold my position and still spend money without racking up nearly any meaningful interest, I'd happily do so, you'd kinda have to be crazy not to since there's no downside (the principal keeps on earning for you and there's very little cost to service the debt). Companies do stuff like this all the time, there are a million good reasons to maintain debt even when you have assets you could otherwise liquidate, especially when rates are low. Besides, unless it's given away to charity the bulk of the wealth will be taxed at death anyways via estate tax, so I'm not entirely following the nefarious implications here. I guess people are mad that the borrowed and spent money effectively escapes taxes since it's paid by the estate pre-estate-tax, I guess? I'm reasonably sure that no bank would loan someone in this situation anywhere near their entire net worth, so I can't help but feel like this is a very edge-casey small issue that is only a problem in the rare years where interest rates are so low that it makes sense to do this...

novok 5y ago
So what kind of rich do you have to be to get near AFR loans. Cheapest I've seen is IBKR right now at %1.6 with a margin loan.
- cornel_io 5y ago
  Eh, I guess that's not super accurate, no bank will loan at AFR, you're correct. But an LLC with cash in the bank that you control or owes you a favor can and will, and that's completely on the level as long as you pay AFR rates.
- MattGaiser 5y ago
  Scroll further down on the IBKR table. 1.6% is the rate everyone gets. If you manage 200 million for example, you pay 0.75%. Some other currencies have 0.5% interest. https://www.interactivebrokers.com/en/index.php?f=46376 https://www.interactivebrokers.com/en/index.php?f=46376