Monday, January 21, 2013

Is Being Debt Free Financial Insanity?

I saw a tweet recently by Robert Kiyosaki and wanted to comment on it. Here's the tweet:
My first reaction: If being debt free is financial insanity, what about someone who has BAD debt? OK. OK. That isn't fair. I realize he only had 140 characters and wanted to grab people's attention. If he had more than 140 characters, here's what I think he would say.

Of course BAD debt is... well... bad. We should strive as much as possible to get out of BAD debt. That's a given. Yes, doing that is much harder than saying it, but this isn't even the purpose of his tweet.

Kiyosaki is claiming that if you want to build wealth, being debt free won't do it (it's insane). I get the impression this is a dig towards Dave Ramsey who really pushes for people to become debt free.

In the end, balance is key.

First, you must spend less than you earn to build any sort of wealth. BUT, you can't spend so little that you're miserable. Start here: experiment by changing one of your regular habits: make coffee at home, switch to a smaller cable package, or ride your bike to work.

Second, you should strive to pay off BAD debt. BUT, you don't want to neglect having an emergency fund and potentially put yourself in a worse situation when life happens. Start here: tackle high interest credit cards. Then roll that payment to other debt. If you have a lot of debt, it's OK if it takes a few years to pay it all off.

Third, you should invest in assets and leverage those assets with debt. BUT, you should not leverage yourself to the point that you can't make payments when life happens and the assets don't produce as much as you want. Start here: stock market index funds are great because you buy companies that have GOOD debt (excluding a handful of tech stocks that have no debt), and are managing that debt well. You're personally debt free, and take advantage of organizations that have GOOD debt.

Will that build wealth super fast? No, but it'll work over the time of your career. The best way to speed up the process is to figure out how to improve the world and start doing that. That might be in the form of a side business, or increased responsibilities at your primary job. Either way, if you make the world better, you will be rewarded. Instead of increasing your standard of living, you can buy more assets and build wealth faster.

Being debt free isn't insane. It's a safe and proven path to building wealth. Though, it does take longer than leveraging yourself and it may mean you never get to drive fancy cars or go on exotic vacations.

Using GOOD debt within reason, also builds wealth. Though it does mean you'll have to actively manage something/someone and is riskier if you don't have the skills/time to do a good job.

What we do

Our current strategy is to spend less than we earn and use the extra money to get out of all our consumer debt (including student loans) as soon as possible. Then we'll focus on buying assets that are leveraged with debt (I like actively managing our assets). Then we'll let those assets pay their own debt down. Eventually, it'll make sense to pay off our GOOD debt too. That point in time will be when our assets, if they were debt free, will be able to sustain our standard of living. Technically, we won't be maximizing our potential wealth, but we're trying to find a balance between building wealth fast and risk.

UPDATE
I had a friend make a comment on Facebook I thought worth sharing:
"I think it would be helpful to specify that Good debt is debt that allows you to make more money by utilizing it's power in situations where you would others wise have no power to purchase said capital. Like buying a multi-unit property, where you don't have the capital to purchase it outright but make the Good debt work for you!"

Image: bfpublishing.com

2 comments:

  1. I've never really understood the American concept of debt. You can't buy anything if you don't have debt. But debt in itself is considered a bad thing. Why do you want to establish the credit worthiness of somebody with the amount of debt he/she has, when the credit worthiness of someone who has no debt is self explanatory? Meaning that no debt = never get bogged down with BAD debt.

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  2. redfredisdead4:50 PM

    Your greed driven ideas are taking the whole planet down a narrow, dark lane to a place no-one in their right minds would want to be.

    Here's a quote from a long gone 'american' worth remembering:

    “Only after the last tree has been cut down. Only after the last river has been poisoned. Only after the last fish has been caught. Only then will you find that money cannot be eaten.”
    and you won't be able to eat your 'debt!' either...

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