This video and article will advance your thinking about debt, to help you think intelligently about one of the biggest debts many of us get into: purchasing property.
Now that I work for a bank as a researcher, I get to listen to how people think, and see how they act about money, and learn even more about how money works. Recently interviewing some business owners, I was struck by the range of attitudes towards debt.
I used to think that all debt was bad: “avoid credit cards!” and “if you can’t pay cash, you can’t afford it!” were messages I got from my practical working class family members. But, I observed, lots of people got into debt, and on purpose: for their house, car, education…
Once I started learning from folks who showed me how people make money, it began to make sense. Not all debt is “bad” – just the debt you can’t pay. (And even much of that you can file bankruptcy out of, except student loans sadly.)
So, when you take on debt just make sure you have a plan and a backup plan to un-debt baked in.
That’s strategy — and that’s what we’re going to dig into today. Watch the video, or read on below to learn more.
Debt can be a burden when we get, or are forced, into it without a clear way to undebt ourselves, like when you spend more than you make or suddenly have to live off credit cards due to a worklessness crisis.
But, debt is also a way to use someone else’s (usually a banks’) money to achieve your goals.
Sure, you pay them, but you also get value. The trick is to get more value than you pay the bank, and then you’re essentially Winning Capitalism, the Game.
You’re literally leveraging capital: using money, to make money. And, before you throw Marx at me — remember that whenever you use your money, you’re leveraging your capital — we just don’t usually think about it like that with our little tiny personal finances. “I buy a pre-made bread so I don’t have to stop what I’m doing to make a break. You, the baker, get money, but I get my time value — worth it!”
Yes: usually, “capital” means “a chunk of money” but ultimately, it’s about understanding you’re exchanging value for value. So, how do you value debt? Purpose, or math, friends.
- PURPOSE: It this debt allowing me to keep cash on hand for a purpose? For example: I could pay cash for this car, but I’d rather have more in savings, in case I need it to fix the car.
- MATH: It this debt allowing me to use that cash on hand to invest, instead, and will make more money in that investment than I would to pay off this debt? For example: it’s cheaper to borrow money for this car than it would cost me in the long run to not put this money into my 401k, so I’m going to keep investing even though I could choose to throw more money to pay off my debt.
These are usually presented as rich business people concepts: spend your money with a goal and plan. But honestly? I think they don’t get to have all the strategy out there.
You, too, can combine some business-y concepts into your overall understanding of money. Why? Again:
It lets you assess the cost and benefit very strategically, in order to make informed decisions about paying off debt vs keeping it and using your money otherwise:
- Am I liquid enough? Eg do I still have cash on hand for other needs
- Am I leveraging? Am I using someone elses’ money and keeping what I have available?
- Am I doing the math and checking on the 5%* rule? Am I paying down debt that costs me more than 5% and trying to earn more, leaving “cheap debt” as is to stay liquid, and trying to earn more than 5% with the money I am keeping in the game?
At the most common level, this practically looks like deciding to contribute to a retirement investment plan even when you’re still paying down student loans or credit cards. You just get SO much more value out of the money you put into the plan over the long term, than you are paying to service your debt in the short/medium term it’s worth it. Especially if you’re getting an employer match.
Why analyze debt?
I learned about this stuff once I started really wanting to understand buying investment property, because the heart of the financial decisions are all about leverage and cost of capital (the 5% rule). Am I using someone elses’ money more cheaply than I if was using my other money, to make money?
But, when I was deciding whether to put money into a work retirement plan vs pay off my 2.75% student loans [I am Gen X], it helped me decide.
We’re going to dive into property purchases in the next few posts (and newsletters), so stay tuned for more!
*Some people use a 6% rule — as long as you have assessed a reliable amount you might earn from an investment, and use it as a rule of thumb to decide to pay off a debt vs invest, either one works.