I have met many who say “I am proud of the fact that my house & car have been fully paid off, I have even paid off all of my student loans. Now I am financially stable!”
These people are usually in their mid 40s and have decent jobs. Now, there is some truth in these statements but the problem is that the person saying this hasn’t looked at the bigger picture.
Since the central bank of most countries keep on printing more money, and since that newly printed money is an IOU (i.e. a loan), the issuance of this new money incurs interest. This is because all money these days isn’t money, it is debt. Guess who pays the interest on this newly created currency? Yes, it is the general public, meaning you and me.
We just don’t see the debt payments happen, because they are disguised as inflation, taxes and other expenses. This means that even if everything you own is owned free and clear, you are still in debt since your government has a debt clock which increases exponentially every single second of every day.
So technically you are still in debt, whether you see it or not.
Anyway, I digress.
The Rich & Debt
The point of this post is to tell you that the rich and the middle class (and the poor) think of debt in a totally different manner. The rich use debt to finance investments which will bring them a much higher ROI than they have to pay to service the debt.
This literally means that even if they have millions (or sometimes billions) of dollars of debt, they are very comfortable.
The debt isn’t weighing them down. It isn’t even binding them in chains.
The debt is liberating them.
This is because the rich incur good debt, debt that makes them rich.
The General Public & Debt
The middle class and the poor do the direct opposite and then wonder why they are in a predicament. These social classes use debt to buy liabilities, goods which are known to lose a lot of value over time. This includes cars, TVs and surround sound systems, watches, expensive clothes etc. They use credit cards to purchase these items and most of them are not able to settle the credit card debt immediately, resulting in massive interest being charge on their purchases.
Ever see a 30 year old take out a brand new BMW 5 or 6 series and flaunt his wealth? The irony is, he most likely has no wealth since the car is a depreciating asset which will cause him to work twice as hard just to keep at the same level of wealthiness as he was before purchasing the car.
All these examples relate to bad debt, which makes you poor. This is exactly what I mean by debt which chains you down and causes you to have sleepless nights. It is literally a million dollar lesson to know the difference between good debt and bad debt.
Difference Between Good & Bad Debt
Let’s take a sneak peek into what good debt really is:
- A person with high financial IQ puts down 20% as a downpayment for a duplex and takes out an 80% loan on the value of the duplex at the interest rate of 3.5%. If he rents out the duplex to two different tenant and has makes a monhly profit after paying off the mortgages, taxes and other expenses, he is using debt to get wealthy.
- Someone which good business acumen takes out a $1,000,000 loan at 7% to expand his business. If he makes over 7% every year in profit after all business expenses, he is using debt to increase his net worth.
Now let’s look at how bad debt can give you nightmares:
- A 35 year old guy buys a new BMW Z4, starting at $44,500 since he has “some extra money” and a “nice stable job”. What he doesn’t look at is that the car forces him to service around $600-800 per month as payment on the debt. It also increases his monthly maintenance costs by at least $300. His debt is making him poor, binding him down and if he loses his job, the BMW dream will turn into a nightmare.
- A 60 year old mechanical engineer buys a $950,000 house & sells his older (and cheaper) house in the process, in order to transfer the equity. What he doesn’t understand (or doesn’t care about) is that the bigger house will increase his monthly mortgage payments, property taxes and the general maintenance by a huge factor. Yes, the property might appreciate in the future but that is a bet which has a 50 50 chance of winning or losing. Taking on a large debt position where you yourself are making the payment on that debt is almost always a losing proposition.
So when you make a purchasing decision in the future, irrespective of whether it is property, a car or a service, always objectively try to understand what the benefit is to you. There’s a saying that “Not everything that glitters is gold.” In the financial world, this saying rings especially true. Most good investments do not glitter, do not draw attention & therefore only show up for people who are actively looking for them.