There is a rising interest (pun intended) among investors about the returns offered by debt funds, so I thought I’d write an introduction to approaching investment in a private credit or debt fund.
Why Invest in Debt Funds?
Debt funds often offer high yields, in the 8% preferred return range, with a profit share after the pref. They pay out regularly, are backed by debt that is often senior in the capital stack and is, on paper, a great potential way to turn a few hundred thousand dollars into a few thousand dollars per month in income. They are usually more liquid than many other types of private or syndicated real estate-related investments, with lockup periods of two years or less in most cases.
Debt funds typically pay out simple interest, so they are particularly attractive for investors who have, or plan to have, little in the way of realized income, who have or plan to have large losses that they can use to offset simple interest income, or who choose to invest in debt funds via tax-advantaged accounts like self-directed IRAs.
I personally would be greatly interested in using debt funds as a tool to meaningfully subsidize my healthcare costs. Imagine putting $50,000 to $100,000 of HSA funds into a “self-directed HSA” (yes, this is a thing), investing in debt funds yielding 9% to 11% simple interest, and then using any interest to reimburse healthcare-related expenses in early or traditional retirement. Any excess interest could, of course, be reinvested in the funds.
Debt funds are likely a poor choice; however, they are for investors using after-tax dollars and earning a high taxable income. In most cases, effectively, all returns will be paid out as simple interest, and you will pay taxes at your marginal…