Is debt good or bad? Well, it depends on how you pay for it. One thing is for sure – this topic is a lightning rod. Some people are diehard proponents of leverage and debt, and believe that financial success is in many ways driven by debt. Many others, most notably Dave Ramsey, believe and teach just the opposite. They think that he who borrows becomes a slave to he who lends, and that debt puts financial success in jeopardy.
This is a difficult and multifaceted conversation, but let us try…
Monetary System and Debt
First, I have to note that we live in a debt society in which the currency is fiat, money supply grows as a function of something called fractional reserve banking, and health of the economy is in large part a matter of something called velocity of money. Theses are all interesting, and in some ways sinister topics, but I have no intention to write about those in this post in any detail – I invite you to do research. What all this really means is that if borrowing stops, economy dies – we nearly experienced this in 2008…
Basics of Money
Think of money as a flow, which is why we call it Cash Flow. now, picture yourself inserting a mesh filter into this flow of dollars – what happens?
Let’s say there are $100 in the flow of money, and the filter that you’ve chosen is good enough to capture 10% of this flow – this means that $90 will pass through the filter and emerge on the other side while $10 will stick to the filter. Do you have this imagery?
You Are the Filter
Now, realize that you are the filter, and the amount of money that you can capture is a function of several things:
One – how able you are to put yourself in the path of the money flow?
Two – how effective of a filter you are?
Three – the magnitude of the flow of money.
Let’s just say that you work hard and are able to position yourself in the path of the money flow, so number 1 on my list is taken care of. Let’s also say that as a filter, you are able to filter out 10% of the flow. What can you do to catch more money in this case?
Well, there are but 2 things:
One – you could improve your filter, and instead of 10% of the flow, catch 15%, or 20%. This could be a viable solution, though this is quite difficult to do.
Another option is simply to position yourself in a larger, thicker, faster flow of money where more dollars are flowing faster through you. In this case, even if you are able to catch only 10% of the money flow, the dollar amount that settles with you will be larger simply due to the increased flow.
For example, if the flow of money which passes through you increases from $100 to $500, then by capturing 10% of the flow you now will be able to retain $50. And if the flow of money increases to $5,000, then you will retain $500, etc.
So – the question then becomes:
How do I increase the flow of money through my filter?
And, while it’s not the only answer, one of the primary answers is:
Leverage and Debt
Income-producing assets, such as rentals, cost money, and unless you are independently wealthy and have an unlimited supply of cash, you will need to leverage debt into acquisition of real estate. Real estate, by the way, is a prodigious filter, and the more of it you control, the more money flows through you.
Thus, debt is the key!
But, Dave Ramsey is Right
Yep, in the most pure sense of the word, debt enslaves us. Having to owe someone something gives them power over us.
How to Reconcile the Two
So – on one hand, debt is necessary for growth, as illustrated in my “money mesh” analogy. But, on the other hand, debt enslaves us. How do we reconcile the two ideas, because they are both right…?!
Well, there are only 2 ways to avoid a life of servitude due to debt:
One – You can avoid debt all together, but this will more than likely inhibit your growth in a debt economy.
Two – You can deflect the responsibility for this debt away from you and onto someone else…
That second item is interesting. The focus here is on the debt service, and not the debt in and of itself. Understand, the thing that enslaves you about debt is that it costs money every month, and if you are spending your hard-earned W2 income on debt, then two things are true:
For one thing, this is money you could be saving and/or investing, which you are not. And more importantly, if for any reason you cannot make the payment, you will be in trouble.
Should You Use Debt?
Simple – you have to have someone else make your debt service payments for you. Look at it this way:
When you borrow money, it makes you a slave to the lender, but only in a sense that you have to make payments and eventually pay the loan back. However, if you manage to rig things up so that you are not the one making those payments, then you in essence deflect the serfdom away from yourself and onto someone else.
Consider investment real estate – why is it so good?
Because it is a prodigious system by which to deflect responsibility for debt service away from yourself and onto someone else. You take $10,000 cash out of your checking account and go borrow $90,000. You buy a 4-plex for $100,000. Your debt service on that $90,000 loan is about $520/month. Congratulations – you are now enslaved to the bank…
But, you turn around, rent those units, and make so much money that having paid your mortgage and other costs, you manage to put cash in the bank. Congratulations – you’ve deflected the essence of your serfdom (paying on your loan) away from yourself and onto your tenants.
Question – does this mean that you’ve now enslaved your tenants, who work hard at their jobs so they can pay for your mortgage…? What’s more, once you grow large enough, then above and beyond paying paying for your mortgages, the tenants pay for your very life style, your vacations, your kid’s medical bills, and that Tesla you drive!
I am aware that some of the terminology in this article is less than palatable – serfdom, slavery, etc. But, regardless of how it makes you feel, this is the reality. In a debt economy someone owns, and someone is owned. The basic question is – which side of this table do you want to sit on…?
Whether you are a slave to your debt, or its master depends on who pays for it!