Some Thoughts About Debt
One of the greatest challenges that many people have on the road to wealth is managing debt. This has certainly been a personal challenge for me. While I still have a ways to go to get to where I want to be, there have been certain ideas, concepts, beliefs and affirmations that have helped me dramatically increase my understanding and increase my wealth. While this is certainly not an exhaustive study of debt, I think you will find some ideas that will help you as they have me.
What is Debt--Really?
It may seem a little basic to start here, but I think that if you really want to learn something, it often helps to start with the basics. The dictionary defines debt as: "something owed such as money, goods or services." For the purposes of this article we are going to focus on the money aspect of debt. For this reason, I don't particularly find this definition helpful. I prefer to think of debt in terms of cash flow. I have come to define debt as:
An obligation (liability) to pay a person or a business a specific amount (usually plus interest) in the future--usually out of future cashflow. There are some very important points about this I don't want you to miss:
- When you incur a debt, you are taking on a liability. I like putting this in my definition because it reminds me where it goes on my financial statement. Remember: wealthy people accumulate assets. The poor and middle class generally accumulate liabilities.
- Assuming that I don't have the
cash now, I am pledging future cashflow in order
to buy something now. What I like about this is
that it puts the emphasis on cashflow. If you are
going to accumulate wealth, you must protect your
cashflow. When you take on an a liability, you are
decreasing your future cashflow. When you
take on a debt, this means that you have to generate
enough cashflow in the future to both pay the debt
and your current expenses.
If you are decreasing your future cashflow to pay back this obligation, you need to make certain you have a very good reason. - When you incur a debt, you are almost always have to pay interest. This means you are paying a premium to the lender for the right to benefit now.
Is All Debt Bad?
No. There is good debt and bad debt. Debt that you take on in order to buy "doodads" is almost always bad debt. Doodads are luxuries that you buy for your personal use. They can be anything from books, to a meal at a restaurant, a televisions set, furniture, car or even your home (I know that sounds controversial--more on that later). In other words, things that will not put cash back into your pocket in the future. That's not to say you should never take on "bad" debt, but if you want to create wealth, you need to really keep this to a minimum especially when you are first starting out.
Good debt is what you take on to purchase a cash producing asset. In the best case, the positive cash flow from the asset is greater than the negative cash flow from the obligation. For example, if you borrow the money to buy real estate to rent out or sell. Or if you take out a loan to start a business. This is debt you are taking on to increase your future net cashflow. If you make the right investments, this can help you increase your wealth very, very fast.
If you take out a loan for business purposes, it is critical that you carefully evaluate the opportunity to make certain that your cashflow estimates are accurate--conservative is best. If you are unrealistically optimistic in your projections, you can end up in a severely negative cashflow situation that could be difficult to get out of. I have seen this happen to close friends on more than one occasion.
This may seem an odd statement in a website about positive thinking and affirmations, but not when you understand that affirmations are simply a tool to help you maintain a frame of mind that gives you the best chance to succeed. When creating plans and evaluating business opportunities, I do everything I can to be brutally honest and conservative in my projections. I minimize and manage my risk by looking for opportunities with a low downside and high upside. That's one reason I really like the internet. The costs are low, I have no employees, no additional product costs (I'm doing everything electronically), and the potential is high (worldwide). This is especially true since I started including ads on my website.
Debt is Critical to Our Economy
Not only is not all debt bad, debt is critical to our economy. Just think of what would happen to the economy if debt didn't exist:
- Most people would not be able to buy their own home.
- A lot of students would not able to go to school.
- A number of small businesses would never get started.
- There would be a dramatic shrinkage in the money supply. This is because banks actually create new money when they issue debt. Isn't this interesting? Without getting into all of the details, banks have mathematical formulas they follow to determine how much money they can lend out. For example, when you have a deposit of a few thousand dollars in the bank, they may be able to turn around and make loans of 2-3 times that amount. That is new money created by a bookkeeping transaction. New money pumped into the economy to create more jobs and more cash producing assets.
- Some businesses would not survive if they were not able to accept payment by credit cards. Business on the internet would grind to a halt. Restaurants and retail stores would have a very difficult time. The car industry would take a huge hit.
The problem is not with debt but how we use it that determines whether it is good or bad. The problem is not with debt, it is within ourselves--in our own thinking habits as reflected in our spending and investing actions. As with everything, right thinking is the starting point. And that's where Power Affirmations can give you a huge advantage.
Good Debt Can Be Extremely Helpful to Increasing Your Wealth!
Good debt, debt that you use to buy assets that increase your net future cash flow, can help you become extremely wealthy. In fact, many people would never be able to create significant wealth without the wise use of debt. Too many people get so hung up about debt that they end up missing out on really big opportunities. Here's a very simple example:
Let's say that you find a real estate investment that costs $100,000. If you pay for the entire investment in cash and then sell it for $110,000, what is your rate of return? 10% (10,000/100,000).
But let's say that you only put down $20,000 of your own money and borrow $80,000. Now when you sell the property, for $110,000, what is your rate of return (cash on cash)? It's not 10%--it's actually 50% (10,000/20,000). That's because you only had to invest $20,000 of your own money to generate $10,000 profit. This is what is meant by leverage.
This is a very simple, even simplistic example. Life is definitely more complicated than this. To really make this work, you will have to study and analyze potential opportunities. I recommend getting general information how to do this from books and specific information from professionals in your area. Because it is their job to help people make investments, they have a vested interest in helping you learn how to do it in a way that creates profit for you. One of the problems with going to a seminar is that a lot of the information is too general, way too expensive, and they don't take you through the deal. Instead, get some good books, meet some local experts, take a college class, etc. There are other options available than expensive seminars. Quite often, you are better off taking that money and putting it into a real cash producing asset.
I know that getting out of bad debt is an important topic to a lot of people. This article is getting a bit long, so I will offer some practical advice on how to get out of bad debt in my next article. Also, because getting out of bad debt is such an important topic, I want to make certain that the article focuses only on that topic.