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On the Fidelity account page that displays my holdings online, I noticed banners saying I could make extra money by lending my securities. I ignored this on the premise of “too good to be true.” Then I got an email from Fidelity advertising their Fully Paid Lending Program and read what they had to say. By following a link, I was able to get an assessment of each of my accounts telling me which holdings might be eligible and how much they might yield.
The account assessments said I did have eligible securities, all of which were ETFs, and that I could earn interest by loaning them to others, apparently short sellers. The interest estimates ranged from 1% to 10% based on the loan market for each security. This interest rate is security specific and varies from time to time based on the market for each security. Interest accumulates during the month and is paid out after month end.
Still skeptical, I did an online search independent of Fidelity and found that other brokerages have substantially identical programs, including Vanguard, Schwab and Interactive Brokers. The primary caution I picked up from my online search was that tax favored qualified dividends paid on a security while it is on loan will be passed on to you, but it will be in the form of ordinary income not as a qualified dividend. Of course, this only matters in taxable accounts.
The security does not have SIPC insurance coverage while it is on loan. The program description explains that when a security is loaned out, Fidelity deposits an equivalent dollar amount into a bank account as collateral in the event the borrower fails to return the security. The collateral is adjusted periodically to account for changes in the market value of the loaned security.
I’m also relying on the reputational risk Fidelity would suffer if a client-lender lost money on this.
I enrolled my wife’s and my Roth IRA accounts as a test. I had to answer a few questions to qualify each of us for the program. Also, only accounts with a balance of $25,000 or more are eligible.
The pixels on my electronic signature were barely dry when an ETF we both own was loaned out. The interest was 8.88% and together we would receive $45 per day in interest. Counting my chickens before they hatched, I quickly calculated we’d realize $1350 per month. Not so. Both loans lasted one day. We made $45.
I now have 3 months experience. I have made fifteen loans and my wife has made six. I say “made,” but we do nothing… the security is just swept away and returns just as seamlessly. The loans have been for as little as one day while some have been as long as five days. Sometimes my entire position in an ETF is borrowed and other times it is just a partial position. The actual interest rate paid has ranged from 0.75% to 13% being a somewhat broader range than the initial assessment predicted.
To give a sense of the range, I had one loan of 39 shares of an ETF valued at $900 that lasted five days and yielded me 4 cents per day. The largest windfall was a four-day loan on a $128,000 position at 12% yielding $171.40.
The ETF position that has had the most activity is FENI (Fidelity Enhanced International ETF). We hold it in both accounts and together those two positions represent 96% of our 3 months of income payments with interest rates varying from 8.88% to 13%. The high interest rate and the frequency of the loans suggests that during this time period, there has been a big demand to borrow this ETF. I realize this could evaporate. As an example, I hold another ETF in my account that has never been borrowed… will there be demand for that in the future?
Our total additional income for three months for both accounts was just over $500, or just over $160 per month. This will cover several free lunches.
Clearly, this is not going to make me rich. On the plus side, I don’t have to do anything. And, since the interest is paid into our Roth accounts, I will never have to pay taxes on it.
Would this work for you? It depends on whether you have holdings that are desirable for lending and how big those positions are. This is where the assessment comes in.
This may be the closest I’ll get to an investment free lunch. What am I missing?
Vanguard has been touting their lending program lately too. My holdings are all in broad-based index ETFs, I’m not sure if those appeal to people who want to bet on a sector.
Is there any problem with lending from an IRA? The securities would effectively be removed from the IRA briefly and then returned.
If you mean is this the equivalent of a distribution, apparently not. To me the reason to use an IRA account is 1) the investment horizon is long term; 2) for most people, the frequency of trading is low, and 3) any it doesn’t matter if the distributions get converted to ordinary income.
I’ve been in the Fidelity program for about a year. I signed up all my accounts but the securities borrowed are rarely more than 1% of my assets. I see this as minimal risk. All my investments are index ETFs. I usually only see a 0.25% interest rate, but have had a few for 2-6%. Most money received in a month was about $100, but it is usually $5-20.
Thanks for letting us know more about this program at Fidelity, Vanguard and others. It is not for me, and one reason is my ETF’s like IVV are rarely used. Meme stocks, I do not hold. 80% of my portfolio is in S&P500 ETF’s.
Wishing you the best, and hoping no pitfalls. If it works for you great, but I believe there are NO free lunches. Time will tell all.
Thanks Howard. Very interesting. I was not aware Fidelity had this program.
They make it sound as if there is no risk to this loan. Fidelity puts up cash in their bank account to cover the possibility that the borrower doesn’t replace the securities. What if there is a financial crisis and Fidelity/you can’t get access to the money in the bank account because the account is frozen? What if the bank account isn’t covered by FDIC or other government guarantee and some or all of that money is gone? What if you can eventually get your cash collateral out of the account, but not until months or years later? And what if you eventually get cash back but you have lost interest on that money for all that time? I don’t know if these “what if’s” are possible or if there are other “what if’s” that could stand in the way of you recovering your securities or cash equivalents plus interest. But I still believe in the “no free lunch” idea. Maybe the risk of loss is low here but I can’t believe the risk of loss is zero.
Neil: All good questions to ask. The title of my post was somewhat facetious because there is never a free lunch. The fact that Fidelity qualifies investors before accepting them in the program is an indication that you should not plan to complain if the investment goes south. Here is how I have mitigated my risk:
1) My wife and I have 6 Fidelity accounts and 1 Vanguard account. We have enrolled only 2 accounts. 2) The accounts enrolled are Roth accounts that we should not need for years, if ever. So, if I have a loss, it won’t impact my lifestyle. 3) If there was ever a need to recoup money from the collateral bank, I would not need that to happen quickly.
One other point: On their website description of the program, Fidelity notes that they are the counterparty to the transaction. In other works, I am lending to Fidelity; they are lending to the short seller. I would be looking to Fidelity to make me whole in the event of a hiccup.
Howard, thanks again for this information. I did a little searching on Vanguard’s site and found this page that explains their program. The Vanguard program sounds similar to Fidelity’s. One difference: the site says that to be eligible “you must have at least $500,000 in assets held at Vanguard”.
The Fidelity requirement of $25,000 that I mentioned was for the specific account being enrolled in the program. You also must answer questions that address your experience as an investor. I don’t recall if they addressed overall assets with Fidelity.
I have been doing this with Fidelity for almost a year. When I got the email from Fidelity asking if I wanted to participate, I called my Fidelity contact to get her opinion. She explained it and answered my questions so I signed up. I have five Ishares term date TIPS ETFs in my traditional IRA that are desirable to short sellers. The program works as described and I have been paid interest rates between six and thirty percent (not a typo). Some months I get a few dollars. Some months I get hundreds of dollars. It is seamless and I still own the ETFs, I get the dividend income and I can sell the ETFs even if they are on loan. Since the loan is fully collateralized with funds held at US Bank, the risk is minimal and the extra income is a free lunch.
Thank you for sharing. I have not had the experience of selling a borrowed security. I understood that I would be able to but it is nice to have validation.
Thanks, Howard, for sharing your 3-month experience. My husband and I were wondering how it worked.
Howard, thanks for sharing this. Like Dan said I was aware of short sales. I thought the borrowed shares usually came from a brokerage firm’s inventory. I just looked and found that many brokerage firms use client’s margin accounts, with their permission, to loan shares.
Does Fidelity require a margin account for this program.
No margin account required to do this.
Howard, thanks for giving us the detail of your history with lending your ETFs. I know the mechanics of short sales, but never understood where the short sellers borrowed the securities from. Your post has been very educational.
Interesting. Never heard of that but I own funds not ETFs. Sounds like some people are day trading ETFs. Obvious question would be “what could go wrong”? Maybe nothing. One other question: what happens to any interest or dividends paid while the ETF is on loan?
You will receive a payment in lieu of any dividend paid while the security is loaned out. The difference is that it will be considered ordinary income for tax purposes rather than dividend income.
I’m doing this, too. If you look closely at the documentation (e.g., fact sheet), Fidelity tries to get your shares back before the ex-dividend date if it’s in a taxable account. If they don’t, they track that and once per year they give you an extra 27% of what would have been qualified dividends, to compensate for the increased taxes.