The Complete Wealth Management Podcast Episode 9
Cash vs. Loan: Deciphering the Tradeoffs
Dave A: Hello everyone. And welcome to the Complete Wealth Management Podcast. I'm Dave Alison, and I have two of our special guests and our advisors at Alison Wealth on with us today. We have Conrad Levesque and David Roth. How are you guys doing today? Doing well. How about you, Dave? I am doing awesome. David, good to see you again.
Thanks. Uh, two episodes in a row here, joining us, uh, the stock option episode, episode eight was awesome. Appreciate you jumping on again. Yeah,
David Roth: it's great to be back and it's good to see
Dave A: you, Conrad. Awesome. Well, in today's episode, uh, we're going to be talking about something. It actually came up for me personally, and I know we hear it from clients all the time when they're thinking about making a major purchase.
It's really this decision of do I pay cash? Or do I finance it? Do I take a loan out? [00:01:00] And so we want to just go through kind of deciphering some of the trade offs of taking a loan out to basically fund a major purchase versus paying cash. And quite frankly, over the last three, four, five, six years, This has not been much of a conversation because interest rates were sitting at historically low levels.
I mean, we were able to obtain financing at 2 3%. I think my mortgage rate right now is 2. 65 percent on a 30 year mortgage. Well, as we all know, we saw historical interest rate increases in 2022 as the Fed was fighting inflation, and now it's very commonplace to see loan rates at 6, 7, 8 percent on a collateralized loan.
And if it's an uncollateralized loan where you're not literally pledging like a physical asset like real estate or a car or boat, then you could see much higher [00:02:00] rates. 8, 9, 10, 11, 12%. Of course, if you go out to the loan shark, maybe you're going to get it for 20 to 25 percent and a broken leg along the way.
Also, if you don't pay it on time, but again, you know, this is a much bigger decision now to decide to finance a major purchase. And so. What we want to do is just walk you through what some of these tradeoffs are, some things that you should be thinking about and different ways to impact your wealth.
Again, at Alison Wealth Management, we're all about helping high net worth families explore and implement strategies for better wealth outcomes and using debt to pay for things. could really enhance wealth outcomes depending on the financing and the terms of that loan. And so, um, as, as you guys know, David and Conrad, this kind of came up for me more recently.
Uh, I just made the decision to buy a new boat. And on top of that, we're actually doing some remodeling on our house. And so I've been conflicted with this decision of, you know, selling [00:03:00] investments, paying cash versus loans financing. And I can kind of walk you through some of the The decision points that led me to the conclusion that I arrived at in making these bigger decisions.
But I know, you know, we're talking to clients all day long about this stuff, whether it's doing renovations on their house or maybe buying a bigger house, getting rid of that two, two and a half, 3 percent mortgage. And now, you know, with rates at seven or 8%, monthly payments are a lot bigger. So I'm excited to kind of jump in and hear some wisdom and insight from you guys, as well as how you think about this.
personally and uh, across kind of how we're advising clients. Yeah. And
David Roth: I'd love to hear Dave. You mentioned that you had a recent purchase that came up. So I guess before we go into the details, like what's your thought process behind this, what, what, what comes up as you go through and, and deciding whether to finance or whether to pay cash, um, is it anything particular?
Dave A: Yeah, well, there's [00:04:00] two components of it, right? There's the personal component, and then there's the mathematical or analytical component of it, right? And so, um, yeah, for me, when I think about these big purchases, the first thing I always think about is, is why and not so much how, like, why am I buying this?
What is it gonna do for me? And I think you guys obviously know, I'm very big believer in kind of bucketing, um, bucketing money, but also kind of bucketing goals. And one of the things that my wife and I do is, you know, we look at kind of a short term bucket. We call it the soon bucket, of course, at Alison Wealth Management.
And not only what financial things need to go in that soon bucket, but also like what life decisions and choices are gonna be made in that soon timeframe. And for. for us, like over the next five years, there was two things that were kind of important to me. Number one is, I think, you know, as both of you know, and many of our listeners know, um, you know, my oldest daughter had some, some health issues.
She was diagnosed with type [00:05:00] one diabetes about two years ago. And so that's caused, you know, some, some stress on Alana and I, and You know, making sure that she's taken care of when she's not under our supervision, whether it's at school or whether it's at her friend's houses or on play dates. And so as I think of kind of the next five years, one big important goal for Alana and I was kind of to turn our house into a place that all of her friends would want to come over and play at.
And we have a great swimming pool. We're on the water, so there's a lot of good things going, but we wanted to build a cabana and a little outdoor living area by the. By the, uh, swimming pool. And so that was a renovation project and like, it was really, really important to us, not just like, so we can say, Hey, we have this cool cabana, but it really kind of fed into easing our anxiety over the next five or seven years, as she goes from seven years old to 10 years old, to 12 years old.
Hopefully this could be a really cool place for her, her friends to hang out. Um, the second thing, you know, that was important [00:06:00] kind of for me personally is I always try to like Set one personal thing in my soon bucket that brings me a lot of personal fulfillment because at the end of the day like I know we all work really, really hard.
We commit a lot of time to work and we need to just disconnect and do things that we really enjoy, um, to bring us, you know, better fulfillment and passion in life. And as you two know, for me, that's fishing. Um, I wanted to upgrade into buying a bigger boat and part of my five year plan is that I could spend three days a month.
offshore fishing. Like, that's a good way for me to disconnect and recharge. And, um, and so, you know, I kind of outlay those two things first because, like, they really fit into my bucket plan as, like, a per a personal thing. a family thing. I also try to set a business objective in that soon bucket or a professional development objective.
I try to encourage my wife to set like a personal objective in that [00:07:00] soon bucket. Uh, my kids are starting to get of age where they can set some of those objectives. And so, you know, I think just taking a step back before we even talk about the how we pay for this, it's the why. And kind of really digesting that.
So I thought, you know, that might be helpful. At least it's an exercise that I've been doing for several years. As I think about bucketizing my own life, my goals, my objectives, and then my money, but, uh, we'll certainly jump into the, how do you two do anything like that?
Conrad: Yeah, Dave, I certainly do. Um, it's interesting you talk about goals in the bucket plan.
I love this concept. I talked to all my clients about how we look at time horizons, right? And what we put into buckets outside of how we pay for it. We have to understand, and you, you mentioned the why, right? Why are we even doing all this, right? What is driving us to accomplish all of this stuff that we want to, right?
And then [00:08:00] ultimately, uh, from there, I love having that personal goal because that's the tangible part, right? I talked to clients about what are the things that you want out of life, right? That you can't put a price on. And, and, and ultimately I think. Having that understanding means we get to look at things and say, yeah, should we pay cash?
Should we, should we finance? But, right, is this really important to us? I think coming up with that initial decision to buy, right, kind of taking the step back, what's the why? Should we do this from the beginning? It, it, it tends to simplify how we start thinking about how
Dave A: we pay for it. Yeah, absolutely.
Money is just a means to achieve those goals and objectives that are most important to us. And, you know, typically what we find in talking to clients about money is there's a deeper meaning behind those goals and objectives. Like me, you could see, you know, on the surface, oh, building [00:09:00] a pool cabana may be a little bit more superficial of a goal, but when you dive deeper into understanding the why of wanting to create this environment from an anxiety standpoint, it changes the perspective totally.
David Roth: Absolutely. Yeah, and just to add to that, the, the why, I mean, a lot of it to me, um, is, um, has to do with, with time horizon too, like, why do you want to do this now? Why do you want to do this today? Versus why do you want to do this in five years? And that's going to play a big part into the decision, whether you're going to pay cash, whether you're going to finance, because I, you know, uh, you might not have to, to purchase the thing that you want today.
It might be a home. It might be something that you're going to pay off over 15, 30 years. And so if you were to pay cash on all of that, it might not be available. So it's kind of a, also a why, uh, in relation to the time horizon as well.
Dave A: Yeah, no doubt. And David, I know, you know, you know, I love this book, die with [00:10:00] zero.
We've given it out to many of our clients, but it's that whole idea of like. You know, so many people like wait till later on in life. They spend so much time kind of saving and accumulating, thinking, Oh, I'll be able to do that in five years or 10 years or 20 years. And the reality of it is none of us have any guarantee that we'll make it five, 10, 20 years.
And I'm not saying like, don't be prudent and financially wise with your money. Don't go squander everything. Of course, that's not the good financial advice that we would give. But there is that trade off and you make a great point and we'll kind of just dive into the weeds here a little bit because obviously all three of us are financial advisors, we're investment advisors, we're tax advisors, and so we geek out on the numbers and we'll kind of jump into the how right now.
But when I think of the decision of cash versus a loan. Um, David, you brought up the first thing. Like, many of us take out a loan, quite frankly, because we don't have the cash to buy the purchase that we need [00:11:00] now. I mean, I know, um, it would be very hard for me or for me to have three years ago when I bought my house here in South Carolina, paid cash for it, right?
I financed it. I took out a mortgage because I really loved this house. And I knew I could afford the monthly payment of the house, but I couldn't afford a lump sum of cash, so I didn't have an option of cash versus financing, right? I had to go the route of financing in this case, and I think, you know, the big decision point in financing is Can you actually afford the house, right?
I'm not sitting here saying like go take out this massive loan because so many times we've seen the big mistake with how easy credit is right now is people can become house rich and cash poor, meaning you take out such a big mortgage for such a big house that then almost all of your discretionary income goes to satisfying and paying that [00:12:00] mortgage, and you don't have any money to go enjoy the other more meaningful fun things in life, travel and vacations and saving and spending time with friends and going out to dinner.
And so I think, you know, Understanding if you're in a position of, um, like cash flow analysis and planning, there's certainly a way to overextend yourself quite easily when you think about trying to buy all these things today. And for many of our clients, um, I know we help them kind of manage what those cash flows and expectations are.
So they don't get in a point when, you know, almost all their income is just going to service the debt. But You know, once you kind of have arrived at a certain point and, and, you know, outside of maybe like a big purchase of your home or a massive remodeling project, in many cases, there is that trade off of do I pay cash or, or do I take out a loan?
And so that's, um, that's some of the things that we're going to jump into. I mean, [00:13:00] David. If, um, you know, kind of throw it on you, I guess, like, what are some of the, the cases or benefits of paying cash for something right now? Yeah,
David Roth: I think the, one of the biggest benefits I always see is that. There's no debt.
There's no monthly payment. There's no cash flow. And this is maybe not as intangible, but there's, for a lot of people, they just don't like having that weight. It's, it's an intangible, just not loving having debt. And I, we run into a lot of clients who they prefer just to have zero debt on their balance sheet.
They prefer not to owe money to people. So I think that's one of the biggest thing is just paying cash. Additionally, Depending on what it is, what the purchase, um, it might be, you know, it might be actually less expensive for you to pay if it's, uh, let's say it's something that you're going to pay with a credit card or something that has additional fees.
Sometimes it's a little bit cheaper to pay that with cash. So those are a couple reasons, but I'm sure there's [00:14:00] more.
Dave A: Yeah, I recently had to put an air conditioning unit in the house and uh, if I put it on my credit card, he was gonna charge me 5 percent more. If I paid cash, he gave me a thousand dollars off.
Like, that was a very, you know, in my opinion, a no brainer situation. Because I had the cash on hand. Again, I totally understand many people, they need to put it on that credit card so maybe they can pay it off over 12 or 24 months, or maybe they could find a credit card with a promotional no interest for a year or something like that.
So, um, again, I think that's a great point in thinking about this cash decision is could you get a discount? Could you get some money off? Um, any other thoughts on paying cash? Kind of Conrad, David? Yeah, I
Conrad: think, you know, when we look at paying cash versus financing, the benefit to paying cash is, you know what the cost is, right?
And I think with financing, a lot of times we [00:15:00] look at a monthly payment, we don't look at the overall cost. Think about buying a vehicle, and I'm actually about to go do this this weekend, right? I need to upgrade a vehicle, and so I'm going to look at it and say, what is my actual cost of this depreciating asset?
That's a big key point here, right? Am I overpaying for something that's going to drop in value, right? Or do I lock in what equity I have today? I think that knowledge of, I want to target spending X dollars means I get to do that while paying cash, whereas I don't get to do that.
Dave A: Yeah, and that's a super point you just brought up is like, what are you actually buying?
Also, are you using it to buy a liability or something that's going to depreciate in value like a car or a boat? Or are you using it to buy an asset that's going to hopefully appreciate in value like a home or a rental property and I want to kind of dive into that in a little bit when we [00:16:00] talk more about some additional factors to consider, but the other thing that I'll just share on kind of the case for paying cash.
Before we flip over to some ideas on using loans and then kind of bring it all together, is if you pay cash for something, one way to financially get ahead is take whatever that monthly payment would have been had you financed it and use that to pay yourself. Use that to dollar cost average into an investment portfolio.
And what I mean by that is if I have the option of taking a 100, 000 loan out today to do something, and it's going to be 7 percent interest, We could basically factor what that monthly payment would have been over a 10 year repayment schedule to pay off that 100, 000 loan plus interest. Now, if you went to, let's say, your [00:17:00] investment portfolio and you liquidated 100, 000, Now what you could do is take that same monthly savings and start accumulating it back into your investment portfolio.
You're taking advantage of a financial concept called dollar cost averaging, where you're dollar cost averaging on a monthly basis back into the stock market. And what you'll find is over four, five, six, seven years, You'll probably have replenished all of the money that you outlaid for that first capital purchase and and then some just depending on how the stock market performs.
And so again, I think that's a really important concept if you do decide to pay cash is don't forget to kind of calculate in your cash flow how you can pay yourself. To be able to continue to replenish that, you know, kind of asset in your soon bucket.
Conrad: Dave, I love that [00:18:00] unintentional plug for the bucket plan, right?
I, I love this concept of let's look at it and say, let's liquidate this asset, but take now those funds and refill the bucket, right? You can look at it as kind of a waterfall, right? We filled our now bucket. We keep our emergency savings there. But let's refill the soon or later buckets with, with cash flow because we just had a big exodus of, of, of dollars from the portfolio.
That's a very important concept that it seems so simple when we say it, but I think it's harder to, to put a, uh, uh, you know, it's, it's, it's much harder to, to put an actual dollar amount on what that
Dave A: means over time. It does. And I think the biggest thing we see is, you know, people don't actually, although it seems like common sense, people don't implement it because they don't have somebody to hold them accountable.
I think that's part of the value of the work we do as financial [00:19:00] advisors is hold our clients accountable to saying, Hey, all right, let's take this 250, 000 and out of your portfolio and pay cash for, you know, this home renovation project. But, Let's make sure that we're taking two or three thousand dollars a month and automating a pay yourself first savings plan so that five, six, seven, eight years from now you've rebuilt some of that.
And so, um, absolutely, I agree. Let's flip the script and talk about kind of the power of leverage with loans. So David, you brought up a great point earlier. Um, on how sometimes we just quite frankly need a loan because we can't pay cash. Now, loans are not all bad. And, you know, one of the concepts you brought up in our last podcast with stock options was the power of leverage.
Can you talk a little bit about kind of how you would think about loans and some of the, you know, things that might encourage somebody to go take a loan and, you know, what maybe they should [00:20:00] consider as they're weighing the trade offs of cash versus loans? Yeah, and
David Roth: again, that concept of leverage is really the key, and the way I always like to think of it is just a real simple example of if you purchased a home for a million dollars, but you only had to put 100, 000 down, and it has a 10 percent increase in the home value.
Now you put 100, 000 down, a 10 percent increase, you've increased 100, 000 of value. So now, you've essentially had this really large gain. with only a 10 percent increase. Now, let's say you had that same 100, 000 and you, you know, put it down, you had a 50 percent gain, uh, over that time period. That would only be 50, 000.
So, essentially, you need less of a gain in order to have, um, have a large increase with that leverage. So, I mean, one of the big factors of taking a loan, especially when you have an appreciating asset, is you can have larger leverage.
Dave A: Hey David, I want you to repeat that. That was really important. I love the [00:21:00] numbers you use.
So give that example one more time. Like, so, and I would encourage anyone listening, like write this down. So if you, if you buy a million dollar home. And let's say you put 100, 000 down. Go through that one more time.
David Roth: So you purchase a million dollar home, you put 100, 000 down, a 10 percent increase on the million dollars that that value of your home is going to be 100, 000.
So again, you put down a million, uh, 100, 000, but your gain is actually going to be 100, 000 because the amount that your investment is increasing. Um, The, the, the home is increasing is 10%, but the amount that your investment is going to increase is going to be essentially double.
Dave A: So basically a 10 percent increase in the market value of the home turned into a 100 percent increase in your down payment or your investment.
And, and I love that. That's the concept of leverage because to your point in contrast, that if I [00:22:00] took a hundred thousand dollars and I invested it in Some stocks, bonds, mutual funds, and ETFs, and they went up by 10%, or yeah, now you go from 100 to 110, 000, right? So, um, now the reality of it is there's risks with leverage too, right?
So, uh, leverage as much as it could compound the upside, it could also compound the downside. And we'll talk a little bit more about that, but any other kind of big picture ideas on the power of using loans or leverage when thinking about making a major purchase.
Conrad: Yeah, I, I think we need to talk about the business impact or, or just the, we'll call it a business impact thoughts on, uh, you know, buying rental real estate, or how about if as a business owner, you, you look at leverage, uh, in terms of what cashflow is generated from the purchase of an asset, right?
And is that cashflow greater than the cost or the, the monthly outflow? [00:23:00] Uh, of, of those same dollars. And I think that's the power of leverage because now you get to say, well, I'm generating income from an asset, much like a rental property, right? I'm generating more in more income than it's costing me.
And I have some excess each month. That's your profit. But let's go back to David's example and say, now the market went up 10%. Now you still get that a hundred thousand plus. You're having somebody else pay
Dave A: the loan. Yeah. So Conrad, I think, you know, you're bringing up a really important point here is you're using the loan to buy an asset, not a liability, an asset that maybe could either appreciate in value or generate cashflow, let's use rental real estate as the most simplistic example.
If I could go take a loan out at 6 percent interest. Which might be a far fetch these days, right? Maybe it's more like 8 or 9 percent on a rental property. But let's say I could take a [00:24:00] loan out, 100, 000 at 8 percent interest. That's 8, 000 in that first year of interest that I'm paying. Plus, let's say there's some maintenance expense, there's some management expense of that rental property, and all together between interest, maintenance, expenses, you name it, it's 15, 000 a year of total expenses for that rental property.
Conrad, to your point, as long as that rental property is bringing in more than 15, 000, you have a positive arbitrage. So you're using somebody else's money. to help make you money, to generate you cash flow, and the kicker is, if that rental property appreciates in value over time, you get the capital appreciation of the asset.
Now, of course, there's a lot of tax stuff that we have to throw in there, which uh, we're not going to cover in this episode. We'll do another episode on [00:25:00] rental properties later on. But there's a lot to think about with rental properties. I think that the gist of what you're getting to, Conrad, and you mentioned this, David, also is, is there an opportunity for arbitrage?
Arbitrage is when you could take kind of one financial asset and use it to get ahead on another. And a simple example of that is Imagine that I could borrow money at a 3 percent interest rate, borrow 100, 000 at 3%, and turn around and put it in an investment that guarantees me 4%, right? Well, that's a 1 percent positive arbitrage.
That's a good financial play. I remember I did a video on this a couple years ago when inflation was really soaring back in 2021 and 2022 and the government was issuing, issuing I bonds that were paying 9, 10, 11 percent [00:26:00] interest. I know for me, I was borrowing money from places that I could borrow at a low rate, and I was putting it in investments like that, that guaranteed that interest.
And an example would be, I borrowed from my securities backed line of credit at the time, which is basically a line of credit I could take against my post tax investment portfolio. And at the time, the interest was about 2. 99%. Then I take that money and I was buying I bonds with it that were giving me 10 or 11%.
That's about a 7 percent arbitrage, right? I was paying the interest on one side, and I was earning the interest on the other, and the interest I was earning was a lot greater than... The interest I was paying. Well, quite frankly, there's not a lot of that that exists today on a guaranteed basis, right?
Because now we see interest rates are seven, eight, nine percent. And [00:27:00] even a risk free treasury bill is only at about four and a half to five and a half percent, depending on how long you lock in that guarantee period for. So. There's other ways though. There's non guarantees, right? Non guarantees are you could borrow and invest in the market and hopefully the stock market goes up by more than the cost.
You could borrow and go into real estate. Uh, those are all the kind of decision points to think about as you, you know, kind of, way these trade offs of taking money out. And again, the purpose of this episode is not to say, like, go take out loans and buy money in the stock market. Like, that's not what we're recommending by any means here.
We were just using those as illustrative examples of things that you should consider. Now, the other thing that I just want to share And then, you know, we can kind of close up some of these ideas on using loans and give everybody listening some real life examples of, of considerations [00:28:00] here is the other power of taking a loan is you keep liquidity.
So if you're using somebody else's money, you're paying an interest rate to them for that, let's say to the bank. You are now keeping liquidity in your own money that if a financial emergency arose, or you needed it, or an opportunity came up, you have that liquidity. And there's a big benefit to that for some people.
You just need to properly weigh what the cost of that liquidity is and if that makes sense for your situation. And I'll give you an exact example in just a moment here of how I weighed the trade off of that decision when I made this purchase of the boat and kind of walk you through the, the, how I thought about that and, and ended up arriving at the decision that I made.
Conrad, David, anything else on loans before we kind of just go into some other factors to consider? Yeah, I
David Roth: think, [00:29:00] you know, one thing that's been eye opening, I'd say, over the last few years is not just loans, but the different types of loans and different options you have for loans, and a lot of times it's not so much that you're going to need a loan, but you have the option for one, and I'll give you an example, something like a HELOC, a home equity loan, if you have a line of credit, if you have that line of credit, It gives you more flexibility so that if there is a major purchase that comes up, you don't need to wait for that.
You, you don't need the liquidity. Um, and I, I've thought it's been interesting some of the ways, and we might get into this in a little bit, that we've used other things like family loans, bank loans, uh, like you said, the secure, securities back line of credit, and also life insurance as loans. So just, again, not having just one particular option where you could, uh, get, get a loan from, but just knowing that the trade offs of all these.
Dave A: Yeah, that's a great point and a great segue because you're exactly right. I mean, one of the things that we were, uh, you know, kind of always talking to our clients about is we want flexibility and we [00:30:00] want options, right? And I think that, you know, let's say, for example, I spent my entire savings building money in a pre tax retirement account, like an IRA or 401k.
There's very little ability to take loans from those types of accounts or that type of money, right? I think, what is it, 50, 000 is the cap you can borrow? And it's not really a good idea because if you leave your job, and that's for the 401k, not the IRA, right? The IRA is nothing. But if you leave your job, it creates complexity and we generally don't advise borrowing from those places unless it's kind of an area of last resort.
But if you have a number of different financial assets, whether it's retirement accounts, whether it's post tax accounts, whether it's real estate, whether it's business interests, even things like permanent cash value life insurance, you have the ability to borrow against those. And so you could look at all of your options and say, well, which one of [00:31:00] these things would provide me the most favorable terms?
And terms are not just The interest rate, that's a very important one, but it's also what's the repayment period. Are there any pre payments, uh, penalties if you pay it off early? Uh, so those are just some of the things to, to think through, I think that you're alluding to, right, David? Yeah, absolutely. So let's go ahead, Conrad.
Conrad: Sorry, I was actually gonna I was gonna ask David, you know, you mentioned borrowing what feels like from yourself and and that's a concept and I've been reading up on. I don't know if we even want to touch on it. The concept of of infinite banking or banking on yourself, right? Have you seen that David or Dave in real life and have kind of a tangible example?
Yeah, absolutely.
Dave A: Yeah, I mean, I think those are kind of marketing names for a concept that, you know, maybe gets misinterpreted a little bit, um, [00:32:00] but they are very, very, um, kind of real and, and honestly I use them for myself and I'll talk about it kind of how I arrived at buying the boat and, and what I did there, um, in many cases, but, um.
But yeah, you're, you're exactly right. I mean, those are, are concepts where at the end of the day, you've accumulated assets and I don't care kind of where you've accumulated them. As long as they're traditionally not in an IRA and you have the ability to essentially pledge those assets as collateral. To in essence, like Conrad says, borrow from yourself.
You're pledging your assets as collateral and then borrowing back. And quite frankly, like the ultra ultra rich have been doing this forever. Right? Take Elon Musk. When Elon
Musk bought Twitter, now X, he borrowed a bunch of cash against his Tesla stock. And he used that to buy Twitter. Now, he's also sold a lot of Tesla stock to be able to come up with [00:33:00] the cash, but what you see is multi millionaire and billionaire families do this all the time. ProPublica actually released a big piece, it was called Buy, Borrow, and Die.
And the gist of this piece is that you buy assets, Instead of them, instead of selling them and paying capital gain, you borrow against them and you have a carrying cost, which is the interest rate. And then at some point you die with these assets and your family gets a step up in basis. Or in the case of a life insurance policy, they get a death benefit that essentially pays off the loan, and you end up not paying tax.
And again, we're not going to get kind of deep into that concept in today, but I think that the overall point is when you're thinking of this concept of cash versus loan, I'll kind of step you through my thought pattern when I bought the boat. So I needed to come up [00:34:00] with a pretty fair sum of money. It was a new boat, pretty big boat, and enough to get me 20, 30, 40 miles offshore here in Charleston.
And, um, the first thing that I did was I looked at the areas that I could borrow from. And what the terms of those loans would be. And so in my case, I could go to a traditional bank and take out a personal loan, which I looked at the rates and they were like 10 to 12%. Very costly, but very easy to get. I have good credit.
The other thing is I could pledge my post tax brokerage account and take out a securities backed line of credit, which would allow me to borrow 70 to 80 percent of my market value of my stock account. And the interest rate there was about seven and a half percent right now. Now there's also some risk because if the market crashes [00:35:00] 30 or 40%, That lender could call that loan because now my investment portfolio hasn't fully collateralized the value of the loan.
So although that may be as a lower interest rate than a personal loan, there's some risk in taking that type of a loan. You know, maybe you want to really be in a Diversified portfolio or something that has some more stability versus, you know, like some crazy volatile stock or cryptocurrency, which I don't even think you could, well, you can borrow against and people do in certain cases, we have clients that borrow against their cryptocurrency portfolios.
And so, again, those are, you know, those were two areas. The third area was I could borrow against my home. I could either do a home equity line of credit, which had a pretty decent rate, or I could do something like a cash out refinance and tap into the equity that I had built in my home. But the downside of that is it really would refinance my entire [00:36:00] property and I would have foregone this very low interest rate that I had in the first place on the entire...
liability of that mortgage in my scenario. Also, I've accumulated a pretty decent amount of money in permanent cash value life insurance. This is kind of the old traditional whole life insurance where it accumulates money in. I get a dividend on that money based on how the insurance company performs. If I were to pass away, My family gets a death benefit to provide for their need.
I also have indexed universal life, where instead of getting a dividend, my interest rate is credited on how the market performs up to a certain participation rate. And quite frankly, I have variable life also, which is permanent life insurance that's just invested in the stock market. And so what I did was I looked at the rates that I could borrow money from and it was about two to four percent on my life insurance, where I would be paying an interest rate of about two [00:37:00] to four percent.
And there's some more nuances into the life insurance because actually they would credit me back that in my policy, so it's known as a wash loan rate, but I'm not going to get into that here. The reality of it is, in that case, I was able to borrow against my life insurance policy. And let's say pay about two to four percent interest.
And so for me, I didn't have enough money, enough cash in the life insurance policies to cover the whole cost of the boat. But what I did was I took as much out of the life insurance policies as I could. to be able to contribute that towards the down payment. And again, my interest rate was between 4 percent there, depending on what policy I borrowed from, because I have multiple policies and they have different loan provisions.
And with that loan, I have the ability to pay it back at any time. So, if I wanted to pay it all back in 6 or 8 months, I could do it with no prepayment penalty. [00:38:00] If I want to amortize that payment over 10 or 20 years, I could do that as well. It's totally up to me. I'm not subject to any terms of the loan provider.
Now, outside of that, when I looked at all of my other options, like, I just couldn't wrap my mind around paying 7, 8, 9%. Because for me, I have money in the stock market, and quite frankly, there's no guarantees that my stock market money was going to generate me 7, 8, or 9 percent return. And so what I did for all the excess is I paid cash.
I liquidated a portion of my stock market portfolio. And I used that to pay off all the difference for the total purchase price of the boat. And so now in this instance. You know, I have the, um, I have a payment on the smaller part of the loan I took from the life insurance policy. Again, at two, three, four percent interest rate.
I'm [00:39:00] OK with that. That's not much of a carrying cost. And then on the other part of the money I liquidated out of the stock market, I am essentially developing my own monthly payment to start replenishing that money back in my soon bucket. And so. That's just kind of an idea of how I would weigh that.
And now, to the point that I think Conrad, you brought up earlier, I bought a liability with that boat. Like that thing, although actually my first boat that I bought two and a half years ago, I'm selling right now for more than I paid for it. So that did appreciate, but that was a kind of weird COVID thing.
Um, this boat, I do not anticipate it to appreciate in value. It's going to depreciate in value. When I think about the second project that we're about to engage upon, which is the renovation of my house to do the stuff in the backyard, number one, that's going to add instant equity to my home, right? I know the next day after it's done, I could flip the [00:40:00] home and sell it for a bunch more than I paid for it and be profitable.
Number two, I know over the next 5 or 10 years, my home value here is going to appreciate even more. So in that instance, quite frankly, I would be more comfortable taking out a 6, 7, 8 percent loan to be able to fund a project like that in an asset that I know is going to appreciate. And that loan interest is going to go down over time.
Because again, my balance is going to be going down. I'm paying principal and interest. And so the other thing to, to kind of think about there is I also don't believe interest rates are going to be this high forever. And so if I take that loan out today at seven or 8 percent to do the construction project, and in two years, 5 percent again, what can I do guys?
You can refinance. Yeah, refinance, right? I could reduce my [00:41:00] interest. I could refinance. And so again, that's the important that anytime you take out debt, a mortgage, a loan, these things need to be managed just as much as your financial assets need to be managed. And so again, A lot of things to think about in terms of that opportunity.
And again, for me, like if I could borrow at 7%, let's say I needed a hundred thousand dollars and I borrow at 7%. Or if I wanted guarantees, I could take that same hundred in cash and invest it in government bonds right now that are paying about 5%. To me, that's a 2 percent negative arbitrage to the lender.
Like I could take a hundred grand and get 5 percent or 5, 000 of interest to me. And if I borrowed a hundred grand at 7 percent interest, I'm paying 7, 000 to the lender. That's negative 2, 000 or 2 percent each year. [00:42:00] To me, I call that the cost of liquidity, right? For me, if I needed that liquidity, that would be the strategy I would do.
I would straddle and buy something guaranteed, like government bonds, and then I would take out a loan so that it costs me a net borrowing cost of 2%, but now I have that liquidity in the government bonds if some big financial emergency happens. So that's another kind of thing to think about. Yeah, and I remember we,
David Roth: that, that came into, we talked about that a lot with our clients as interest rates were rising because we went from the period where it was 2.
5 percent interest rate for mortgages all the way up to what they are now, 6, 7, 8 percent, um, and when you look at it, as you put it, Dave, where you have that, uh, cost of liquidity, A 7 percent interest rate doesn't seem that bad, but in comparison to maybe a 2. 5, it does. But again, it's what could you do otherwise?
You could invest, like you said, in those government bonds.
Dave A: Yeah. You remember we [00:43:00] were talking with the client about that and we said, well, yeah, mortgage rates used to be 2. 75. But you'd only get 0. 5 percent on your interest, right? So that would be a 2. 25 percent difference between what the risk free interest rate is that you can earn versus the borrowing rate that you can pay.
Well, think about where we are today. The risk free rate that you can earn is around 5, 5. 5%. Whereas the borrowing rate is around 8%. So it's still kind of that same spread in net borrowing cost. It's just, it feels worse. for somebody who doesn't have the assets to offset the borrowing cost. And that's the scenario of most Americans who need to go take out a mortgage to be able to buy their house.
Kind of how you opened up this conversation today, David. And that's the big struggle when it comes to financing in this type of interest rate environment. The last thing [00:44:00] that I just wanted to kind of share is you mentioned, You know, we have a lot of clients who have been, you know, uh, who are, who, who have accumulated a lot of assets, quite frankly, who have been very successful.
And, uh, they probably have more money than what they actually need in their lifetime. And the other thing that we've been seeing more and more of right now is intra family loans, where, you know, maybe a brother is making a loan to a sister or a brother, maybe a parent is making a loan to a child. And Let's talk about that real quick.
I mean, we could do a whole nother episode on that, but David or Conrad, any kind of things that clients should think about prior to actually engaging in that?
Conrad: Yeah, that's a loaded question. I think that's probably another two hour episode about what to necessarily think about. Now, I think I want to kind of take a step back and say most people don't even know that that's an option.
But there's, there's specific [00:45:00] rules that need to be followed with intrafamily loans. This isn't just set a 1 percent rate and let it rip. Right? The IRS does actually publish specified intra family loan rates to make it considered an arms length transaction. So, before, before you go down that road, uh, I think that's very important to consider.
The other part of that in terms of considering whether to even engage in that is, look at it like anybody else. Would you loan this person money? Listen, I'm going to be, I'm going to be honest. They're family members. That I have that I would, I wouldn't loan 10. I know I'm never going to get it back. Right?
So you're still acting as the bank and loaning money or right. Somebody is then loaning you money and think about not repaying the bank versus not repaying your parents and going to Thanksgiving, right? That's a very awkward
Dave A: timeframe. Yeah, that is. So I don't [00:46:00] want to loan money to your family then either, Conrad.
David Roth: I will say though, we, we have seen this with success for some of our clients though, because it's an option of, of when you have the, as Conrad alluded to, there's Uh, an interest rate that the IRS sets, and it could possibly be lower than the rates that you get at a bank, so you'd be paying less in interest, and again, if you're a closely, you know, a good, uh, closely held family, or you're, you get along really well, and you're planning to transfer that wealth anyway, it might be a good way to, to start it a little bit earlier.
Like, let's say your kids are just coming out of college, and they want to get their first house, That might be a reason, or again, you have another family member who needs that. So, I mean, we've seen it a few times where it has been really successful in kind of taking away the high interest rates that we are seeing and also, again, putting to work some of the excess money that our clients have had.
Dave A: Yeah, it can be a game changer, specifically with this high interest rate environment. You know, [00:47:00] maybe somebody getting started can't afford their monthly payment at seven or eight percent interest. Well, federal AFR rates are around four, four and a half percent right now. That's the minimum rate that a family member needs to charge.
And quite frankly, you don't even have to charge them that interest. You just have to declare it as income and pay tax on it. And so there's Some things that we do from a strategy and development standpoint when we structure these intra family loans. Um, but to Conrad's point, you can't just say, Hey, no interest or 1 percent and let it rip.
Like you need to have proper documentation, but it can be a huge benefit. Um, as to David, your point, if, if, you know, one family member is just trying to help out another family member, maybe they're so financially fortunate that it doesn't even matter if they ever get repaid. Or maybe it was going to be part of the inheritance plan anyway and now we're just allowing it to benefit the, you know, the family member, um, when they need it most.
And so lots of great options there. Again, so much to [00:48:00] think about when it comes to paying cash, using debt, taking out loans. This is the stuff, again, we do with our clients. All day long at Alison Wealth Management. We've got these two gurus here with us today. As you can see, so many things to think through.
So many trade offs of these decisions. And they do have a big impact on building long term wealth. And so, uh, Conrad, David, any closing thoughts as we land the plane here? I think my closing
Conrad: thought is, um, I'd like to figure out how to buy my own boat. Um, so we'll be, we'll be talking more about that. But I think this is a great topic.
Um, and it, it hits every single person in, in the U S at some point in their life. So,
Dave A: you know, it's better than buying your own boat, paying cash for it, having a colleague that bought it and you could come use it anytime you want.
Conrad: Listen, now we're talking that's, that's right up my alley, right?
Dave A: David, getting the boat up to Boston would be a little challenging for me.
But we got a
David Roth: good Harbor up here, but [00:49:00] final thought I would say is just know your options. So many people don't know that there are the securities back line of credit. There's life insurance. You might be able to ask family. Um, so you don't necessarily need to use them, but it's finding the best option for you at that time.
Dave A: Awesome. Well, I appreciate it, guys. My insight is, uh, you guys continue to provide so much value to our clients. Hopefully this podcast does. Don't forget to subscribe. Check us out on YouTube. Stay in touch with everything we're doing. And if there's anything we can do to help at all, please don't hesitate to reach out.
Go to alisonwealth. com. You could schedule directly with either of these two guys here or myself, and we look forward to helping you.