What is a financial rule you will never break?

View this answer on Musing.io

I am going to answer this question slightly differently to how I might otherwise have answered it, had I not seen other's answers to this Q. 

The reason is that many have said that they "would not go into debt" or "not spend money that they don't have" as a key financial rule. This is all well and good but I think it is vitally important to make the distinction between good debt and bad debt.

Yes, you read that right - there is such a thing as good debt.

Good debt is debt that is drawn down against an asset that has the ability to appreciate in value or provide cashflows that exceed the cost of servicing the debt i.e. the interest costs. Ideally both.

Common examples might include debt or a loan to acquire real estate or businesses. 

In the case of real estate, it is only a 'true asset' if you are renting it out to secure cashflow to settle the interest payments whilst, hopefully, enjoying capital appreciation in value of the real estate during the loan period. At the end of the loan term, you should be able to sell the property for a value that exceeds the outstanding loan principal. You've made a gain on the purchase using the debt. A gain that you are unlikely to have been able to enjoy had you not used (good) debt. After all, how many of us can buy residential or commercial property out of our own pockets...?

And this is what "the rich" do. They use (good) debt as leverage to buy assets that give them positive cashflow during the holding period and then sell the asset for gains later. Meanwhile, everyday folk are warned to stay away from debt. And so get stuck with minimal assets and net worth. This is due to poor financial education.

Bad debt is the experience that most folk have of debt and this is why they steer clear. Bad debt is debt taken out to buy:

• consumables
• assets that lose value over time
• assets that have no positive cashflow (income)

It can be either or potentially all three of these factors that can make the use of debt become bad debt. 

Common examples include loans for cars, holidays, shopping etc. 

In each case, interest is payable on the loan every month with no cashflow income from the 'asset' purchased (unlike for good debt).  This means that the interest expense has to be serviced out of wages or other income. This can be painful. Then at the end of the loan term, the 'asset' has little or no value so the borrower is in a worse financial position than when they started - bled of interest costs during the holding period with little to show for it at the end of the loan.

Rich people NEVER use debt to purchase consumables or assets that don't derive positive cashflow income. This is bad debt, yet this is the debt that most folk are aware of, hence the confusion.

Good debt allows you to accelerate growth (how long might it take you to save up the equivalent funds?), get leverage to free up your own cash for other uses and use other people's money to derive positive cashflow and potential gains - if used right.

And herein lies the key financial rule: 

Consider using debt as a tool to accelerate your growth and to provide leverage as long as it is good debt (secured against true assets) and that you have run the numbers to make sure that it is a sound investment.

(This is not financial advice, yada yada)

#money