When it comes to personal finance, there are two basic schools of thought. The first tends to focus almost exclusively on paying down existing debt while the second actually encourages people to use debt as a tool to become wealthy. While there is certainly no one correct answer that is right for every circumstance, it can be helpful to compare and contrast the various choices one must make between building assets and paying down debt.
Extreme Savers aka Coupon Queens
Paying down debt feels really, really good. There is nothing quite like sending that last check to the credit card company and telling them to bite it forever. Only in America could a company charge twenty-five percent interest and still have people lining up to use their product.
While I would love to be completely debt free, it simply is not realistic at this point in my life. Additionally, I absolutely refuse to spend hours clipping coupons or driving across town to save twenty cents a pound on frozen chicken. There is nothing wrong with that; it simply is not my cup of tea.
Followers of the get out of debt at any cost school of thought tends to look for places to save money almost to the point of being obsessed about it. Cell phone minutes can be cut way back, cable TV is a luxury and dining out is a cardinal sin. Yes, I know that we could cut back on a few of our discretionary expenses but, to be perfectly honest with you, I would rather enjoy my family now and not worry about my debt every second of the day.
Wealth Builders aka ?Debt Leveragers?
If paying down debt feels good, then building a portfolio of appreciating assets can be considered an aphrodisiac; it is that good!
When it comes to building a solid base of assets, however, the main problem that the average person has saving up enough capital to invest in the first place. Just about everyone has heard the old clich? that ?it takes money to make money? yet most people simply do not understand what this actually means.
To the average person, this statement means that the system is skewed towards the rich; never allowing the poor to break out from their current socioeconomic standing. To the wealth builder, however, this simply means that it is often necessary to use debt to acquire assets that will appreciate in value and make them wealthy in the future.
Bad Debt versus Good Debt ? My two cents
You see, not all debt is bad. Sure, adding a massive amount of consumer debt is just about the worst thing you can do (fiscally speaking, that is). If you use debt as one part of a systematic wealth building strategy, you can actually turbo charge your financial progress.
Examples of good debt include borrowing money for investments, taking out a mortgage on a rental property, borrowing money to expand your small business, and even using student loans to obtain educational credentials that will allow you to make more money in the future.
Contrast this to what the average household does and you will instantly see the difference. Having high interest credit card debt or large monthly car payments will not help you achieve your financial goals. The key is to use debt to invest in assets that generate passive income (or capital gains) that exceeds the amount of interest you have to pay on the debt.
Let?s look at an example that may help to clarify this concept a bit more. Last year, Frank borrowed $30,000 to finance the truck of his dreams. At the same time, Sam borrowed the same amount to buy one unit in an existing duplex.
After a year, Frank?s car has decreased in value significantly while Sam?s duplex has maintained its value. Additionally, Sam has been collecting $750 a month in rent from his tenants, which more than offsets the payments he has to make to his lender. In a few years, Sam will have a fully paid for asset while Frank will have a truck worth about 15% of what he paid for it!
Which of these two people will see their decision as a blessing five years from now?
On a personal level, each month I send approximately $100 off to my friend Sallie Mae. For a while now, we have had bounced back and forth between a love-hate and a hate-hate relationship. Let?s face it; there is not much to love about her. Or is there?
Ten years ago, I borrowed money to go back to school. My first degree was a waste of time (psychology), and the job prospects were looking rather bleak. I could, of course, elected to stay out of debt and settle for whatever job came my way.
I, however, wanted a career. I wanted something that made me feel like I was contributing to the world at large. I wanted to do something I enjoyed; not simply collect a paycheck. As such, I went back to school. Since I did not have a job, I borrow the money necessary to do so. Fortunately, I had the where-with-all to only take out what I absolutely needed for school.
I cash flowed my living expenses and shared books with a few buddies. Fast forward ten years and I now have a great career with a company that I really enjoy. Sure I have to make payments each and every month but I now make three times what I would have if I would have settled for where I was. In this scenario, I leveraged the power of debt in order to better my life.
So what about you? Have you ever used debt to build your portfolio of appreciating assets? Don?t forget, that knowledge is an assets and should not be overlooked. Or are you more of a live-in-the moment type of person that loves his or her stuff more than their financial future?
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