Some of you buy mutual funds via your stockbroker or discount broker. This can be very convenient. It also means — if you have a “margin account” — that you can borrow against them, just as you can borrow against the value of a stock.

The advantages of margin loans: (1) low interest, often below prime; (2) it’s deductible against investment income (dividends and interest and, in some circumstances, capital gains).

Why pay 18% on a credit card or 10% on a car loan, non-deductibly, when you can pay perhaps 8% for a margin loan, which in your bracket may really be only 4% or 5%?

But what if you don’t have a brokerage account? What if you just own mutual funds directly? Now comes Fidelity AccessLine (SM), which basically offers to put your Fidelity funds into a Fidelity brokerage account so you can borrow against them.

As borrowing goes, it’s cheap and easy. No appraisal fees, no points to pay, no lawyers to hire or “closings” to attend. Just write a check against your account.

Three caveats:

1. If you have no investment income — perhaps because all your dough is in mutual funds that invest in nondividend-paying growth stocks — the margin interest won’t be deductible. You’ll have to carry it forward to a year when you do have investment income against which to deduct it.

2. If you are audited, you may be challenged on your margin-interest deduction if you were not careful in how you drew down these funds. The IRS looks to see the use of borrowed funds to determine tax-deductibility. Margin interest is normally deductible; but if you moved your funds into a Fidelity brokerage account and then wrote a $199,999.95 check against them directly payable to Captain Tom’s Yacht Dealership — or even just a $19,995 check to the local Ford dealership — the IRS might argue that the interest incurred on this loan was not deductible investment interest, but rather nondeductible personal interest. You might be better off switching $250,000 — or $25,000 — from your margin account to your cash account, and then, perhaps a few days later, writing a check for the specific cost of the yacht or Mustang.

I’m not advocating you do anything illegal or cheat Uncle Sam in any way. The rules on this are so grey, it’s anybody’s guess. As a practical matter, you’re likely to be OK.

3. Even at a low rate, and tax-deductible, borrowing is risky. It only makes sense to borrow at, say, 5% after tax, if you have a way to earn 6% after tax. And remember that the interest rate on your margin loan may shoot up — it’s completely variable — and that if it does, chances are good the value of your mutual fund shares will fall (because rising interest rates often mean falling share prices).

Borrowing against your mutual funds to pay off high-interest debt or even to buy a car or make some other investment can certainly make sense. It’s a way to get cash without, for example, selling mutual fund shares and, possibly, incurring heavy capital gains taxes.

But do it with care. You worked hard to build up those mutual fund balances. It would be a shame to hop on the debt treadmill and find yourself going backwards.

One thing I certainly wouldn’t recommend, let alone with the market as high as it is, is borrowing against your mutual fund shares to buy more shares. In hindsight, that could have paid off big the last couple of years — borrowing at 5% after tax to earn perhaps 30% a year in capital gains. Wow. But leverage works both ways. What if you did the same thing now and fund shares fell 30%? In that case, you wouldn’t just lose 30%. You would lose 60% (if you had doubled up on your initial investment) plus the interest, to boot. Oops.

 

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