By Tafara Mtutu Research analyst
THE United States market is experiencing rising stock prices and low interest rates, and this has opened a unique window for the “Buy, Borrow, Die” strategy among high net worth individuals.
In summary, investors with large equities holdings are taking loans and using their equity portfolio as collateral. These clients then spend the funds how they see fit and, in the event of their death, the loan is settled using the proceeds from the sale of the collateral.
This strategy offers several benefits such as (i) flexible repayment terms and low interest rates on offer, (ii) accessing funding without having to sell off an asset in an illiquid or depressed market, and (iii) avoiding capital-gains tax.
This strategy has garnered traction in the US market because of the strong rebound in equities amid low and stagnant interest rates.
The Dow Jones Industrial Average Index picked up 24 7%, the S&P 500 Index gained 29,5%, and the Nasdaq Composite Index was up 29,6% in the past 52-week period.
Key reasons for the strong performance include (i) relief bills that have injected billions of dollars to support financial markets and corporations that are too big too fail, and (ii) unattractive bond yields that have diverted investments from the bonds markets and towards equities.
The unattractive bond yields are a function of the US Federal Reserve policy rate, which has been held at 0,25% since March 2020 as part of expansionary monetary measures to support economic growth considering the pandemic’s impact on the global economy.
The Buy, Borrow, Die strategy is implemented in three phases, as suggested by the name.
Firstly, an investor buys stocks and builds a sizeable portfolio. Given the index movements in the past 52 weeks, this strategy would aptly apply to investors who have held equities for more than a year because they would have captured the 12-month gains ranging between 25% and 30%.
Secondly, the investor takes out a loan and uses their equities portfolio as collateral. The main advantage of taking a loan over selling the stock is the avoidance of capital gains tax upon the sale of shares.
The capital gains tax in the US ranges between 0% and 20% depending on the investor’s level of income and whether the stocks sold were held for longer than a year or not.
The third part of the strategy would be for the investor to enjoy the funds as they see fit until they die.
The advantage of having the debt repaid using proceeds from the sale of the assets placed as collateral is avoidance of tax through the step-up in cost basis that is triggered when one dies, and their wealth is transferred to their heir(s).
Using the step-up in cost basis, the cost of the equities is “stepped up” to current prices without triggering capital gains tax.
However, this strategy only makes economic sense if the interest and principal payments on the loan are collectively lower than the capital gains tax, which will probably be the case for the typical high net worth investor in the US.
An immediate question that pops up to the Zimbabwean investor is, “Can l apply this strategy locally?”, and the answer to that requires one to explore (i) the local tax policies, especially around the capital gains tax rate that applies with equities, (ii) local policy rates, and (iii) the ease of using equities as collateral, among other factors.
Anyone who has bought and sold shares on the Zimbabwe Stock Exchange has received a deal note from their broker that confirms the purchase or sale of their shares. In the case of a sale, the deal note charges a capital gains tax of 1% regardless of the size of the trade and the investor’s income.
On the other hand, Zimbabwe’s policy rate has been high and steady at 40% since March 2020. Hence, the high interest rates versus the very low capital gains tax make this strategy wildly unattractive even for high-net-worth investors in Zimbabwe.
That said, the option to use local equities as collateral is something that investors can consider in a bid to unlock liquidity with minimal reinvestment risk.
This can be facilitated by a depository like Chengetedzai Depository or ZSE Depository. These entities’ mandate is to provide a facility for holding and/or transacting securities in electronic form, and investors can pledge their shares as collateral through these depositories.
Pledging refers to a process in which the borrower (pledgor) of funds uses securities as a form of collateral security to secure the funds it borrows or takes from the lender (pledgee).
As stated in an article by insiderzim.com, the pledged securities will not be used for other transactions since they will be locked until the pledgor settles the debt for which the securities were used as collateral.
In addition, once securities are pledged, no new pledge can be registered on the same securities. However, the pledgor will be entitled to all the dividends during the tenure of the pledge, provided the securities declare any dividends.
- Mtutu is a research analyst at Morgan & Co. — email@example.com or +263 774 795 854.