Nowadays, many people invest and look ever more inclined to invest in mutual funds because these assets can give them better returns than other investment options. But only a few investors know they can take a loan against these securities, called a loan against mutual funds (LAMF).
Sometimes, you may encounter financial emergencies and need urgent cash to tackle the situation. During such hard times, you may choose to get a loan against mutual funds instead of selling them off. Since not many investors know how to take such a loan, they tend to head to a Mutual Fund Distributor (MFD) or a Registered Investment Advisor (RIA) for help.
RIAs and MFDs should advise LAMF to their clients for the following reasons.
To protect investors assets and long-term financial plans
Firstly, the most crucial problem of an MFD is the retention of assets. Many investors wish to redeem mutual funds at the first instance of a financial emergency. And what makes them do so is that other financial assets like insurance and fixed deposits are not as liquid as mutual funds.
Not only does mutual funds redemption jeopardize their financial growth, but also it reduces the compounding effect on their investment portfolio. With a loan against mutual funds, investors can address their short-to-medium-term fund requirements and keep their growth prospects high. ‘Don’t redeem it, but lien it’ should be the slogan of every MFD and RIA, as it can protect investors assets and long-term financial plans.
To help investors improve their wealth in the long run
Secondly, many MFDs and RIAs advise their clients to create an emergency fund by investing in liquid funds. The sole purpose of such a fund is liquidity during an emergency. Generally, these funds deliver around 3.5% of annual returns, which can hardly beat inflation.
What MFDs and RIAs should do instead is advise the investors to invest in their emergency corpus in an equity fund so they can get better returns and avail of a loan against securities or mutual funds when they need cash to beat financial emergencies. If they go this way, investors will have to pay interest only on the amount borrowed. Another plus is the rest of their investment portfolio will continue to fetch equity returns. This strategy can be helpful and positively impact their wealth in the long run.
To save investors from paying capital gain tax and other taxes
Additionally, mutual fund redemption can attract certain taxes, including capital gain tax. The profit from selling any qualifying asset or investment option is considered a capital gain. If investors choose to redeem shares or mutual funds, they must pay capital gain tax, which ranges from 10-15%. The security held for more than 12 months qualifies as a long-term asset (subject to indexation). And the security held for less than 12 months qualifies as a short-term asset. The tax for long-term capital gain is 10%, whereas the latter attracts a 15% tax. By advising a loan against securities (LAS), RIAs and MFDs can relieve investors from such taxes.
To let investors gain continual benefits from their investments
Another reason MFDs and RIAs should advise a loan against securities is that a LAS or LAMF allows the borrowers to continue to benefit from their investments. The borrowers retain the ownership of the mutual funds even after pledging them against the loan amount they borrow. The securities increase in value when the market rises, and the owner becomes the beneficiary.
Is there any risk for MFDs and RIAs if they advise a loan against mutual funds?
MFDs and RIAs do not bear any risk if they advise loans against mutual funds. That is because the agreement happens between the investor and the company. The lien marking is done in the name of the lending institution, and the loan amount gets credited to the investor’s bank account. Moreover, the repayment transactions happen from the investor’s bank account to the lender’s bank account. So, there is no risk involved for RIAs and MDFs. The reasons above are fair enough to make RIAs or MFDs advise loans against mutual funds to their clients.