Used Wisely, Debt Can Absolutely Produce Wealth: Here’s How
As someone who has struggled for about half of his life with debt, what it really was, and how to handle it, I guess it’s best to start out by trying to define it. I believe this is where some of the challenges in reference to debt stem from.
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Merriam Webster’s Definition of Debt:
- An amount of money that you owe to a person, bank, company, etc.
- The state of allowing money to someone or something.
In other words, debt is defined as something borrowed or owed.
This type of definition then leads to sayings like, “Avoid debt like the plague” and “All debt is bad, dangerous, or scary.” Oftentimes, we’re taught that having everything paid off, or being totally debt-free, is true financial security.
Maybe it’s actually fear that causes us to feel this way — fear of losing what we worked so hard to accumulate. Or, maybe it’s the fear of not being able to pay our debts.
This supposed feeling of security if an asset is paid off doesn’t necessarily mean that the asset is any more productive nor that it is any more secure (especially if insurance is being properly utilized).
Are We Really Afraid of Debt Because We’re Afraid of Expenses?
In a recent article, I covered the attributes of a Scarcity Mindset vs. an Abundance Mindset (“How to Uncover Amazing Deals by Simply Changing Your Mindset”). I believe that the drive to get completely out of debt is closely related to the Scarcity Mindset, as focusing solely on reducing expenses can be quite limiting.
Focusing more on production may be less limiting and, therefore, is more closely related to the Abundance Mindset.
Varied Definitions of Debt
Many people have to distinguish for themselves between their wants and their needs. Teachers like Dave Ramsey, author of The Total Money Makeover, profess brilliant strategies to help folks who’ve lost their way to get their financial lives back on track. One such strategy is to first have an emergency fund set aside, and then to develop a plan to whittle away at the smallest debt, and then to proceed to attack the next largest debt, and so on and so forth.
Other gurus, like Robert Kiyosaki, author of The Cash Flow Quadrant, discuss the differences between Good Debt and Bad Debt. Robert wrote that his Rich Dad would often say, “Every time you owe someone money, you become an employee of their money. If you take a 30 year loan, you become a 30 year employee, and they may not give you a gold watch when the debt is retired.” Rich dad did borrow money, but he did his best to not become the person who paid for his loans.
Good Debt was debt that someone else paid for you, and Bad Debt was that which you paid for with your own sweat and blood. This is why he encouraged rental properties â because the bank gives you the loan, but the tenant ends up paying for it.
For me, it’s not that I believe the normal definition of debt is all wrong, but I prefer the accounting definition of debt, which is:
Debt = Liabilities > Assets
Debt is not just any form of borrowing; it’s simply having liabilities greater than your assets (things that could be converted to cash). The opposite of debt is Equity, having assets greater than your liabilities.
As you may see from the example above, to me, true debt is when your assets are less than your liabilities.
I’m also a believer that the true path to wealth is to increase cash flow and that our focus should be more on creating more assets than liabilities. After all, aren’t your tenants paying off your rentals? So, why not fully utilize your mortgage interest deductions and property depreciation?
Replacing Debt with Productive Liabilities
My favorite approach to defining debt was covered by Garrett Gunderson in Killing Sacred Cows.
He pointed out that liabilities are just a part of life and that we really need to understand the differences between the three types of debt:
- Productive Debt
- Consumptive Debt
- Destructive Debt
Obviously, Productive Debt is essentially borrowing to make yourself or your balance sheet more valuable (for example: real estate, business loans, student loans, etc.).
Consumptive Debt would be like taking out a second mortgage to buy furniture or buy a car to look cool, as opposed to taking out an auto loan for a work truck, which would be considered a more productive type of debt, as it would bring in more revenue for your business.
Destructive Debt is a little different, as the purchase is neither productive nor consumptive; it’s actually destructive (for example, drugs, gambling, pornography, etc.).
I tend to agree with his approach, where you can increase liabilities to increase your wealth and prosperity. This is exactly what I’ve done. I could have stopped at the 10 or 20 properties and tried to pay them down to become debt free, but I’m less inclined to do so, especially if my tenants are paying down my loans for me, and I’m keeping all tax benefits.
I believe in a more productive approach (towards abundance) by leveraging up intelligently and safely and increasing my overall wealth. My wife and I are cash flowing quite nicely, and we utilize insurance vehicles that can easily pay off all our real estate holdings, if that’s something one of us decided to do upon the demise of the other.
Why would I possibly care if our rentals were ever paid off if my wife and children were totally protected with adequate insurance coverage?
So, Let’s Look at Some of Garrett’s Advice
- Never have destructive liabilities.
- Choose consumption wisely. Never incur consumptive liabilities that exceed your assets and therefore put you into debt.
- Never borrow to consume.
- Focus on increasing productive liabilities, or the liabilities that come with greater corresponding assets.
This advice is pretty straight forward, but it doesn’t hurt to consider how productive you are with your debt. Although I believe that the true path to wealth is cash flow and that paying off debt can become less important (especially when utilizing proper insurances), I also understand that there are limits to this strategy. Taking on too much debt could bring unnecessary stress or a larger work load, so it may be equally as important to understand your own personal preferences.
So, how productive are you with your debt? Are you afraid of debt or do you embrace it as a way to build your assets?
Leave your thoughts, arguments and opinions in the comments below!