In the last blog we spoke about the lack of knowledge being the foundation of people’s money problems. So I want to spend a little time sharing with you some of the things I have learned.
This week we’re going to talk about Debt. Before I get into the thick of it I have a few pieces of information I want to share. Let’s talk about the flow of money. How money is made, and how money is spent. Both of these things are the same. It’s the exchange of products for money. Sure it looks different to the one giving money than it does to the one receiving money. Depending on what side of the cash register you are on during the transaction. The goal in making money is to be the one receiving money more often than the one giving money.
Financial debt is the renting of money. That is the transaction between you and the bank. What you do with that money is the difference between good debt and bad debt. Does this debt cost you more money than it makes? Does this debt allow you to build wealth or lose wealth? Good debt allows you to make money, or grow your wealth. Bad debt costs you money.
When you think Bad debt, you might think of credit cards, car payments, student loans, etc. These are all examples of bad debt, yes, but they can also be examples of good debt.
Credit cards can be used effectively to protect your money. The biggest service they provide is a layer of protection between your bank account and the hundreds of places you give out your information. The greatest part of this is they will do this for free (to you) if you just set them up to auto pay. If you look around you can even get 1.5-2% cash back. They KEY here is you should never carry a balance on your credit card. Any balance on a credit card is bad debt.
Car loans interest rates can be both good debt and bad debt. If you can get a rate that is under 3% it is better for you to take out a loan on that vehicle and use your cash for another investment. The trick to making this good debt is you need to be investing that money. If you don’t have the money to buy the car in the first place then the debt is always bad debt.
Student loans are often viewed as good debt. This isn’t always the case. What’s tricky here, is Student loans require you to work hard to make them good debt. If you just go to school and get a degree, then you decide to not use that degree to make you money. (take me for example) That debt would be considered bad debt. Yes, you learn life skills that will help you with all tasks. Yes it can be beneficial to go to school. For the topic at hand, Debt, this action should not have been financed.
Good debt is often thought about as a home loan. This is good debt so long as you can pay the loan, and not be “house” poor. Why are home loans good debt? They don’t put money in your bank account. Well, especially in today’s market, Real Estate provides a hedge against inflation. It’s an asset that appreciates in value that the government allows you to depreciate. On average your home will go up in value ~3% each year. The government says over 27.5 years that the home will lose its value. So they allow you to write 3.6% (1/27.5) of your house off of your taxable income. If you have a $100k home then you don’t have to pay taxes on $3600 of your income, and the home is now worth $103k. Also, over the life of your loan you will pay money to principal. This is literally transferring you ownership of your home from the bank. Another benefit of owning a home is the cost of the loan is usually fixed. Money becomes less valuable by about 3% each year (8.5% in 2021). As you get paid more money because of inflation the overall mortgage becomes easier to pay. These things alone are enough to make buying a home using debt a move that makes you money. There are many other factors at play when buying a home and in the future I will try and write about this topic more in depth.
Other types of good debt can be taking out a loan to buy equipment for your business, taking out a loan to buy a business, and buying rental properties. People also get loans to buy stocks, index funds, or Crypto. This is called buying on margin. I even know people who have bought stocks on their credit card. The tricky part with all of these is the amount of risk involved. You need to decide if the risk is worth the reward. Everyday, banks use loaned money from the government to make money. This is called debt arbitrage. They get a loan at .25% on a massive amount of money and loan it out in smaller chunks to people at say.. 3.5% to purchase a home. These can all be a type of good debt so long as the amount of money made is more than what is loaned.
We think about work and money in the same light, as such you can also be in debt with work. A perfect example of this is an employee and an employer. An employee sells their time to an employer. In this transaction the employer takes on a bit of debt. They owe the employee for the time worked. It’s a form of debt. It’s a good debt. It will make the employer money. They are going to use that stored work (money) to create a product and sell that product to someone else using their time, talent or treasure. They have a solid plan to use the debt owed to their employee to make them money. The employee here in a way is a partner in making money for the business. If not for the businesses money making plan, the employee would have no faith in the employer’s ability to make money.
The question you might have, if you are like me, is how can I get rid of the bad debt and take on good debt? You might not like the answer, but i’m going to give it to you the way I learned it. It starts with work, hard work. If you have debt that is working against you, bad debt, you need to work your way out of it. Yes, you can save some money skipping coffee and you should do this at first. You need to get focused on making money. A few years of hard work and laser focus on paying off your bad debt, and you will improve your situation tremendously. If you don’t make more money than you owe, debt consolidation can help you. You can pick up some extra work for a few months. Dave Ramsey has an excellent program for getting out of large amounts of bad debt. I recommend you going to his programs if this is the situation you are in.
Should you invest in assets if you have bad debt? I have found that this is situationally dependent. As a rule, if you find it difficult to set aside 50% of your income for yourself to invest you probably need to get rid of some of the bad debt. Another rule, if your bad debt has an interest rate that is over 8% it’s probably time to clear it out. I do recommend you invest in your Roth IRA, simple IRA, or other managed retirement investments ASAP, especially if they are matched especially since this is an instant 100% return on your investment.
Time, Talent, and Treasure. The only ways to make money in this world. You can swap your time for money, you can use your talents to make money, or you can utilize your treasure to make money. These are progressive. Use your time to learn a talent that helps you acquire treasure. You will use this treasure to get more treasure. Next blog we will be discussing how to make money and how to make this progression work.