Debt free, one of the most commonly goal most FIRE movement activites endorsed. The reason is that debt is viewed as something to be avoided at all cost. It is common to hear debt crushing peoples and their family life. These makes people wonder why would people even take on debt knowing the risk. In this blog, we will look at why the idea of being debt free is ridiculous. And why learning to manage debt can be a powerful tool to build up your investment portfolio fast.
Money is Debt
Where does money come from? How do we value the dollar? These are question everyone needs to know about money.
The value of the dollar is artifically created by banks. A great example of this is purchasing a property. By purchasing a property, you are required to pay a starting downpayment while the rest would be covered by the bank.
Question time: where does the bank come up with the money to pay not just your property loan, but all other lender?
Answer: Banks borrow money via client’s savings to pay off property loan first. For banks to make a profit, they charge interest for lending out loans.
Types of Debt
There are two main different categories of debt. Namely good debt and bad debt.
Good debt is defined as money owe that allow borrower to build wealth through investing it. Some examples of this are margin loan, mortgage loan and leverage.
Bad debt is defined as money owe that does not build wealth and has high interest rate. A high interest rate is typically interest rate of 5% or more. Credit card debt is one of the worst debt to have to pay interest in because it has a high interest rate of 20% or more.
Why Debt can be the best tool to accelerate Wealth Building
As mentioned based on the banks and property owner story, the rich (banks) borrow money to build wealth (through interest). Learning how to borrow ‘cheap’ money to build wealth is what every investor need to consider when investing.
Leveraging debt with Stocks
Consider this, two investor have a initial capital of 1million. Based on the average S&P500 stock returns, a 1million dollar investment would grow to 1.1million. However, if an investor choose to borrow 1million on top of his 1million to invest. His total return from investing in the S&P500 would be $200,000. That’s a $100,000 gain just from borrowed debt.
Leveraging debt with Real Estate
If the stock market isn’t your kind of investing and what you really like is real estate. Consider this then, if two different investor are aiming to buy a $1million property. The first investor invested 100% of his own money to buy the property while the other investor uses 50% to pay for the home (other 50% is borrowed from bank). If the property goes up in value by $100,000. The one that paid 50% downpayment would be earning more as he was able to leverage the other 50% to provide the $100,000 return.
Leverage funding for business
One of the most common reason businesses fail is the lack of funding to sustain or grow the business. Founder need to learn where they are able to get low interest loan for the business. With better funding, founders are able to invest more into the business by purchasing more machinery, find better talents needed and getting more products to sell.
Why do people view Debt so Negatively?
When we are young, we are often told not to take on debt as the banks will come after you for money. News and people gossip aren’t much of a help, as they always report negatively on people who have become consumed by debt.
According to statistic, 90% of divorce cases are related to money problem. This shows one of the main factors affecting people are money related issue.
How to safely manage debt
Debt is a double-edged sword, wielding it right can provide your investment with huge returns. Use it wrongly and it can destroy your entire finances.
Managed debt and overleveraged debt
Knowing the difference between managed debt and overleveraged debt can save you from making bad financial decision. A properly managed debt is debt that can be fully paid off or invested in less risk approach. An overleveraged portfolio are investment that create too much debt for the investor to be able to paid off the interest.
The news is always emphasising overleverage investment that destroys investor or funds. A great example of how overleveraged debt could come crimbling all your investment is the 2008 financial crisis. Many US investor whom had overleveraged into real estate for paper value ended up losing xx of value.
What many don’t realise is that there are plenty more investor who are using debt to build their investments portfolio.
Yes, even though a recent hype or your research idicates a great buying opportunity in a certain investment. You never know what may happen in the future. For example, the recent case of Luna, a crypto assrt crashed losing over 99.98% of its value overnight.
Constantly revise the amount of debt
Uncontroled debt can led to overleveraging without one realising it. A rule of thumb when taking on debt for investment is having the ability to pay of debt through your own personal income or savings. Never over leverage even though the odds may be in your favor.
Start thinking about debt differently
While it is true that being debt free provides a more peace of mind when investing. It would mean taking a longer period of time to build wealth. Therefore, in my view, being debt-free is ridiculous.
If you would like to know more about improving finances and managing debt. I would recommemd reading the book Robert Kiyosaki, author for Rich Dad Poor Dad explains how the rich get richer through debt. The book explain the approach towards building debt safely and efficiently. I have a link here on Product review on Rich Dad Poor Dad.