I feel like I’m too poor to understand what happens between steps 2 & 3 without having a job. How are they paying the loans off? Where does that money come from? And if they have an income in order to pay the loan, why get the loan to begin with?
The investment assets can be assumed to appreciate at, say, 7% (reasonably accurate historical US stock market performance). The loan is at a lower interest rate (let’s say 3%, which is a number I just pulled out of my ass).
So what they do is take out a loan secured against their investments (which is why it doesn’t require having an income to get approved), get a huge lump sum of cash and put that in their bank account. They make payments on the loan by drawing down that lump sum (along with their living expenses or whatever else they want to use the money for). Since the interest rate is >0%, obviously they would run out of money before paying the loan back, right? Well, that’s the trick: by the time that happens, their assets have appreciated enough to have enough collateral to get another loan, so they rinse and repeat.
Note that the last line (“assets have appreciated enough to have enough collateral to get another loan”) implies that these loans are relatively small compared to the assets backing them. I’m not going to bother doing any actual math, but basically this strategy only works if the expenses you want to cover are some single-digit percentage of your asset value. In other words, if you wanted to borrow $50k/year, you would need more than $1M in assets.
You do this loan thing instead of just living off the dividends because withdrawing the dividends from your investment account incurs capital gains taxes, while getting a loan doesn’t.
So they just pull loans in succession, each time large enough to pay the remainder of the prior loan. Meanwhile the assets continue to appreciate, giving more security against the also increasing (but slower) loans.
When does the loan train eventually stop and get paid up? Death doesn’t usually wipe them out, but I guess liquidate just enough to pay the debt and the remainder goes to inheritance?
Where are you getting a loan for 3% while the stock market is performing at 7%? I always see these arguments, but borrowed interest is almost never lower than gains. That’s why step 2 of any worthwhile financial plan is always “pay off your credit cards and high interest loans”, right after “save enough for an emergency fund”. “Invest your money” doesn’t come until a few steps later.
Banks will happily take 3% risk free from someone sufficiently wealthy given the associated relationship benefits: a multi-millionaire or billionaire is probably going to hire that bank for wealth management and pay fees, etc, etc.
That’s true for most folks, and is why it’s so hard for people who aren’t ultra wealthy to understand just how different the world is when you have that kind of wealth; a world where the law and the financial system and the basic experience of the economy is completely and utterly different due to the power and influence that wealth brings.
Heck, most people can’t even truly grok the scale of the difference between an average person and a multi-millionaire or billionaire. The human brain just doesn’t process large numbers like that well.
I’m far from rich, but I do have a paid off house in a low CoL area, and a have decent chunk of retirement savings put away, and even then I get different treatment: better credit cards, better loan products, etc. The industry calls it “qualifying” but what it really is is monetary gatekeeping.
It’s particularly weird having grown up relatively poor because I’ve lived the shift and can see how expensive it was to be poor, and how relatively easy it is for the rich to get richer.
Yeah this is definitely missing a step somewhere. The loans have to be paid off even if you’re dead. Before your kids get anything your assets are used to pay off your debts. Unless there’s a loophole in there where the kids can assume the debts and somehow get the assets tax free, then this post doesn’t make sense.
**Edit: Ah ok the loophole is in allowing the heirs to use step up basis when inheriting the assets. The whole lifetime gains on the assets goes untaxed.
Debts will also only get paid out of their estate and never transferred on to kids or family unless it is using a joint account or the inheritors explicitly accept it. If they transfer the assets before they die, then die with 0 assets and a ton of debt, the debt just disappears (as far as their family is concerned).
you take out more loans. as long as the interest you pay is lower than the gains you’re making in the stock market or wherever, you’re ahead and not paying taxes.
The current loan gets rolled into the next loan and becomes a revolving door of credit. As long as you don’t spend faster than the assets appreciate you’ll always end up ahead.
Hypothetical: Assets like land and housing are reliably expected to only increase in value.
Once one loan runs out, the assets are worth more and a new loan will be potentially considerably more than the previous.
As a second hypothesis, I suspect that fractional reserve banking plays heavily into this.
I feel like I’m too poor to understand what happens between steps 2 & 3 without having a job. How are they paying the loans off? Where does that money come from? And if they have an income in order to pay the loan, why get the loan to begin with?
The investment assets can be assumed to appreciate at, say, 7% (reasonably accurate historical US stock market performance). The loan is at a lower interest rate (let’s say 3%, which is a number I just pulled out of my ass).
So what they do is take out a loan secured against their investments (which is why it doesn’t require having an income to get approved), get a huge lump sum of cash and put that in their bank account. They make payments on the loan by drawing down that lump sum (along with their living expenses or whatever else they want to use the money for). Since the interest rate is >0%, obviously they would run out of money before paying the loan back, right? Well, that’s the trick: by the time that happens, their assets have appreciated enough to have enough collateral to get another loan, so they rinse and repeat.
Note that the last line (“assets have appreciated enough to have enough collateral to get another loan”) implies that these loans are relatively small compared to the assets backing them. I’m not going to bother doing any actual math, but basically this strategy only works if the expenses you want to cover are some single-digit percentage of your asset value. In other words, if you wanted to borrow $50k/year, you would need more than $1M in assets.
You do this loan thing instead of just living off the dividends because withdrawing the dividends from your investment account incurs capital gains taxes, while getting a loan doesn’t.
So they just pull loans in succession, each time large enough to pay the remainder of the prior loan. Meanwhile the assets continue to appreciate, giving more security against the also increasing (but slower) loans.
When does the loan train eventually stop and get paid up? Death doesn’t usually wipe them out, but I guess liquidate just enough to pay the debt and the remainder goes to inheritance?
Fun fact to compare to stock market.
The housing market in Vancouver BC has appreciated at an average return of more than 15% every year for the last nearly 30 years.
Where are you getting a loan for 3% while the stock market is performing at 7%? I always see these arguments, but borrowed interest is almost never lower than gains. That’s why step 2 of any worthwhile financial plan is always “pay off your credit cards and high interest loans”, right after “save enough for an emergency fund”. “Invest your money” doesn’t come until a few steps later.
Banks will happily take 3% risk free from someone sufficiently wealthy given the associated relationship benefits: a multi-millionaire or billionaire is probably going to hire that bank for wealth management and pay fees, etc, etc.
I’ll have to take your word for it, I guess. It’ll be a long time before I have a million dollars cash.
That’s true for most folks, and is why it’s so hard for people who aren’t ultra wealthy to understand just how different the world is when you have that kind of wealth; a world where the law and the financial system and the basic experience of the economy is completely and utterly different due to the power and influence that wealth brings.
Heck, most people can’t even truly grok the scale of the difference between an average person and a multi-millionaire or billionaire. The human brain just doesn’t process large numbers like that well.
I’m far from rich, but I do have a paid off house in a low CoL area, and a have decent chunk of retirement savings put away, and even then I get different treatment: better credit cards, better loan products, etc. The industry calls it “qualifying” but what it really is is monetary gatekeeping.
It’s particularly weird having grown up relatively poor because I’ve lived the shift and can see how expensive it was to be poor, and how relatively easy it is for the rich to get richer.
¯\_(ツ)_/¯ Presumably billionaires get offered exceptionally favorable terms that aren’t available to the general public, I guess?
Yeah this is definitely missing a step somewhere. The loans have to be paid off even if you’re dead. Before your kids get anything your assets are used to pay off your debts. Unless there’s a loophole in there where the kids can assume the debts and somehow get the assets tax free, then this post doesn’t make sense.
**Edit: Ah ok the loophole is in allowing the heirs to use step up basis when inheriting the assets. The whole lifetime gains on the assets goes untaxed.
Yeah that’s a big loophole.
Debts will also only get paid out of their estate and never transferred on to kids or family unless it is using a joint account or the inheritors explicitly accept it. If they transfer the assets before they die, then die with 0 assets and a ton of debt, the debt just disappears (as far as their family is concerned).
Unless I am understanding that loophole wrong.
you take out more loans. as long as the interest you pay is lower than the gains you’re making in the stock market or wherever, you’re ahead and not paying taxes.
The current loan gets rolled into the next loan and becomes a revolving door of credit. As long as you don’t spend faster than the assets appreciate you’ll always end up ahead.
Hypothetical: Assets like land and housing are reliably expected to only increase in value.
Once one loan runs out, the assets are worth more and a new loan will be potentially considerably more than the previous.
As a second hypothesis, I suspect that fractional reserve banking plays heavily into this.