Intro to SBLOCs

Let's talk about one of my favorite investment tools, which is using ES locks to double invest the same money. If you haven't checked out my video on the buy, borrow, die tax planning strategy, I highly recommend that you watch that first before watching this video, so that you can understand how to use SB locks to do one of the most powerful tax planning strategies out there. So let's go ahead and dive in with what SB locks are.

So, SB lock stands for Securities-based line of credit. Sometimes people say securities-backed line of credit. This can also be commonly referred to as taking margin loans. So make sure you differentiate this when you're thinking about margin lending from buying stocks on margin. I'm not talking about a situation where you want to go out and buy a share of Apple, and you buy it on margin because you you don't pay for it yourself; you buy it on margin by leveraging that purchase. I'm talking about something very different, which is borrowing against stocks you already own. So this can work for stocks and bonds; you basically you're taking a loan against your stock or bond portfolio, and you are doing what we call the "be your own bank" strategy. This is my twist on the "be your own bank," where you are borrowing against your own asset, so you're kind of lending to yourself.

Banks or brokerage firms, wherever you have, you know, your stock portfolio, typically they're going to let you borrow against that. You can take an SB lock against whatever amount is in that portfolio; typically you're allowed to borrow up to 50%. So I'm going to walk you through how SB locks work in practice and show you an example of how you can use SB locks to double dip and double invest the same money. And I'll also talk to you about some of the risk and things you need to watch out for, because as with anything, when you're talking about investing, especially when you're layering on using leverage, you have to be very careful, because this can get yourself in a lot of trouble if you don't know what you're doing.

So let's think about a typical example where we have someone who has a stock portfolio of $2 million. So let's say Mary has a stock portfolio where the current value of that portfolio is up to $2 million. This can be stocks or bonds. I always think of it, you know, in connection with stocks because that's the way I use this strategy, but if you have bonds, you can also typically take an lock against those as well. So because Mary's value of her portfolio is $2 million, she can borrow up to $1 million—50% of that—by taking an SP lock. So let me show you how Mary can do that in a way that she can amplify the returns that she gets.

So currently, we have $2 million invested in stocks, so we are getting the returns on that. I've used a very conservative annual rate of return of 8%. You know, I I think that that's very achievable if you know what you're doing in the stock market and you're not kind of, you know, cherry-picking stocks and trying to to time the market or doing short-term trading. I'm talking about someone who's investing, you know, for long-term in like an S&P 500 Index Fund. So let's say the annual returns are 8%. In a lot of cases, they're they're usually going to be a lot higher than that, but that would give you annual growth—I'm not talking about dividends; I'm just thinking about, you know, growth of of the stocks—that would be $160,000 of returns every year. So that means on average Mary's stock portfolio is going to increase by $160,000 per year. We know that, of course, in practice sometimes it would be less than that and sometimes it would be higher, but we're looking at the long-term growth and using averages. So if Mary just keeps investing in those stocks and doesn't do anything else, then she can expect to get, you know, her 8% return—that's pre-tax, of course—and, you know, net annual gain of $160,000.

So let's say Mary watches this video and decides to use the S lock strategy in order to amplify and increase her her investment returns. So Mary has identified a real estate fund she wants to invest in or syndication. So she takes an ES lock—the full amount, which maybe you wouldn't typically do that, but I'm just showing you so you can see how this would work in practice—she takes a million dollars through an ESP lock against her stock portfolio, and she invests that in a real estate fund. I typically wouldn't do that much money in one fund; you know, I'm just using this as a basic example so I can keep it simple. Let's say that real estate fund gets 10% growth every year. Again, I'm using very conservative annual growth rates. I, you know, if I was invested in a real estate fund and it was only getting 10% every year on average over the long term, I wouldn't be very happy with that investment, but I'm being very conservative so you can see kind of at a minimum the power behind this type of strategy. So if that's the case, that million dollars invested is going to get on average growth and increase in value of $100,000, whether that's for cash flow from distributions from the fund or just increase and, you know, appreciation of the properties themselves; it's probably some combination of both.

So Mary has borrowed against, you know, her stock portfolio; she has taken a loan, so she has to pay interest, and we call that margin interest. So right now I'm using 4% as the margin interest rate. I think this is a very average rate; typically it would be lower, but as I'm recording this video, we're in a very high interest rate environment and interest rates are going up, so they're actually going to be probably higher than 4%, but in most cases it's going to be lower than 4%. We're just kind of in a unique environment, so I used an average of 4% just so we can kind of see how this would shake out. So that means Mary has to pay $40,000 a year on that lock to, you know, to the bank as as interest on that margin loan that she took. So that's still great because Mary's still net ahead $60,000. So I'm happy to pay $40,000 if I'm making $100,000 because that means that $60,000 I made that I wouldn't have otherwise had. So again, I'm happy to pay margin interest as long as my returns that I'm getting from that money I've invested in something else and far exceed the interest rate, then you're getting the benefit of that arbitrage there.

So it's important that you understand that people are like, "Oh, you have to pay interest." Well, yes, I'm happy to pay interest to borrow and and invest that money in something that's going to get me much more than the interest I'm paying, which if you're doing the strategy right and you understand how to invest, that should be easily achievable regardless of how high or low the margin interest rates are. But I want to show you how this shakes out at the end of the day. So if Mary had just done her stock portfolio strategy and nothing else, she is having an 8% pre-tax return every year. However, if she did the double-dip strategy where she invested in an uncorrelated asset that's not really typically correlated to the stock market, she can increase her annual returns to 11%.

One thing I want to point out is that this 11% is on a pre-tax basis. Mary actually gets a deduction—a $40,000 tax deduction—for this $40,000 margin interest that she paid because she used that loan for purposes of investing. So she gets a deduction as investment interest expense against other investment income. So that $40,000 cost—excuse me, that $40,000 cost—is really going to be a lot lower after tax. So you really should be, after tax, you know, tax-affecting that number and thinking about this on an after-tax basis, because while I'm just showing you this to keep it simple, she's not really paying net $40,000; she's really paying a lot less because of the tax benefit that she gets on the flip side for that. So you can easily see that you would much rather have returns of 11% than 8%, and when you think about that on the long term, then the benefits of that, you know, and the the amount of wealth and and the the the compounding you can get there is going to be much higher over time.

And also, I want to point out that I've used a very basic example; I've used very conservative growth rates here. Again, I think these are very conservative, particularly the real estate fund, you know, there there should be investments that are very quality, conservative, safe investments in things like real estate funds and other asset classes that are uncorrelated to the stock market that can get you returns of much higher than that on average. So you can really start to see this number get a lot higher, but it's important that you understand that you are getting the benefit of the difference between or the arbitrage between the annual growth of your secondary investment and the margin interest that you're paying. And again, this looks like 6%; that is again on a pre-tax basis. When you tax-effect the margin interest and the benefit of that deduction on your tax return, this is going to be much higher; it's going to be really more like a 7%, maybe 7.5% or 8%, depending on your tax rate benefit. So the arbitrage that you're getting there is going to grow and grow when you think about the tax impact.

So now that we understand how SB locks work, I do want to talk to you a bit about some of the risk and things you need to watch out for when you're thinking about doing SB locks. So it's important that you be very careful on how you are thinking about the amount of money you can take. So yes, you can take 50% of the value of your portfolio, but be conservative when you're thinking about that. You know, I certainly wouldn't look at the value of my portfolio when it's at its absolute peak, because you know the stock market is volatile; you know, it's going to go down. So think about a reasonable value for your portfolio. I wouldn't necessarily think about it in a down market because then you're going to lose some investment potential there, but just what's the reasonable value on like a reasonable market? What is what is a value? And then think about what 50% of that would be. I wouldn't necessarily go all the way up to that 50%; you can, you know, certainly go close to it, but I wouldn't go all the way up to 50% because of the potential of having a margin call. And what a margin call is is really it's a demand from your, you know, your broker, wherever you have your brokerage account that you're taking the SB lock from; it's a demand from that lender that you need to deposit additional funds in the account.

So with an SB lock, your stocks—or I'm I'm saying stocks, but it could be bonds—your stocks are the collateral on that loan, so you are required to maintain a certain level of value as collateral against that SP lock. So to the extent that your portfolio drops below a certain level—whatever that required maintenance margin level is—then you're going to have what's called a margin call. When you have a margin call, again, it's a demand to deposit more funds and to basically a demand to increase your collateral on your SB lock. These can be bad when you have them. I don't think it's the end of the world; I'll talk to you about how to handle a margin call, but these can be bad because in a lot of cases the bank won't tell you; they'll just immediately start selling your stocks. So there can be a lot of issues with that; you would want to have control over what stocks were sold, what tax lots were allocated to that sell; you wouldn't necessarily want to sell, you know, maybe certain stocks. The bank is just going to do it; they're not going to tell you or ask you what stocks you want sold; they're just going to sell them in some cases. So you need to monitor this. Typically, some, you know, every brokerage account is different, so be careful and make sure you understand what their requirements are. But the one that I use—and this is the most common—is that you've got a maintenance margin of 25% of the value of your portfolio. So if your portfolio starts to to get close to that or drop below that, then you could have what's called a margin call, and that could be bad.

So if you do get close to a margin call, or if you have a margin call and for some reason you you do have some time to handle it, you can do that a number of ways. You can transfer additional securities into that account. So I have two different brokerage accounts, so I I keep my stocks that I, you know, my I I view it as kind of my bank account at E*TRADE; that's where I buy and trade stocks and sell stocks because they don't charge a commission; it's a very user-friendly platform. But I use another platform for my SB lock. So I could transfer more securities from E*TRADE to—I use Interactive Brokers; I'll talk to you in a minute about why—but I could transfer, you know, more securities from my E*TRADE account to my Interactive Brokers account to increase that collateral and to hopefully, you know, increase it enough that I don't have a margin call. You could add cash to your account—that's enough, you know, you could add cash to start paying down that SB lock loan to a level that you're not going to have a margin call. You can also sell stocks yourself to generate cash. So you would much rather do that than if, you know, you're having a margin call; you would rather be the one to sell the stocks, pick the stocks that you know you're going to have long-term capital gains, or maybe pick some stocks where you have some losses, so you could do some tax-loss harvesting there; pick some stocks you don't necessarily want to own, but you would rather be the one selling stocks than the bank just doing it automatically for you. So there's a number of different ways you can handle a margin call when you get close to that. Just monitor that; this is not something you can kind of just put in place and go to sleep on; you have to check the balances. You know, I don't pay close attention to where the market is on a daily basis because I just think that's bad psychology from an investment standpoint, but you do have to understand that if the market gets below x amount or drops like if if we have another tank like we did, you know, 2008, think about the number of margin calls that happened; think about margin calls that came up, you know, after the COVID drop; that was a disaster; the market just tanked. So you want to, you know, monitor that, make sure you have a plan in place if there that ever does happen.

Lastly, I just wanted to mention that you want to shop around for interest rates on those those loans, you know, the the interest that you're paying; it can be drastically different at different brokerage accounts. I would never take, you know, an SB lock from E*TRADE; they have, you know, some of the highest margin rates out there. So I like Interactive Brokers; it's also called IBKR, and I use it a lot. I put a link to them in my comments below if you're interested in doing this; that's the best bank—I don't I've never heard someone say that there was a better place to do SB locks. They have the lowest cost interest that I've ever seen out there. The platform is not super user-friendly in my opinion; you would not want to buy and, you know, sell stocks on that platform because they do charge a commission in most cases. But, you know, it's still—what I do again is I buy and sell stocks on my E*TRADE account and then I transfer it over to Interactive Brokers where I then take the lock, and you can transfer them back if you ever want to sell. You know, you're able to transfer securities between accounts pretty easily, though it does take, you know, a couple of days for that to go through. But again, they have the lowest interest rates on SB locks; they're kind of known for the platform that people, you know, put their securities in order to do these locks. So that's a great place if if you are considering doing this. I wouldn't do it at some of the bigger brokerages because they have really high interest rates, and it's something you want to shop around on because a couple of basis points difference can make a big impact on your net returns.

So this was an overview of SB locks. Hopefully you found this helpful. If you did, please check out my other resources. If this is something you're considering doing, again, understand the risk, be careful, know what you're doing, educate yourself on this, how this works, and make sure you understand what you're trying to achieve from a tax and investment standpoint. This can be a very powerful tool; I love doing this; I do this a lot, and I think this is is probably the best place to go. I certainly would exhaust my SB lock potential before I would ever go take a loan from a bank. For something, that's not to say I wouldn't do that; I I use every form of leverage I can, you know, to to to buy assets and to make investments, but in my mind SB locks are the first and best place to start. So hopefully you found this video helpful; if you did, please like the video and subscribe to our channel.