Debt is always perceived to be the enemy of personal financial progress; and any conventional financial advisor will advise you to keep off debt in your entire life. Much as that advice is logical in many aspects, especially for people who borrow without proper planning; it is still flawed in other aspects. The main shortcoming of the advice on living a debt free life is that it ignores the power of leverage. Leverage is a concept used by the wealthy individuals to create more money for their businesses and investments while using other people’s money. The difference between them and a typical borrower from a bank is that; they are able to sustainably ensure that the money they borrow increases their net worth rather than being a financial burden.
The same principles applied by the high net worth individuals to grow their wealth using other people’s money borrowed from banks and other investors can be applied at an individual level. When you start doing your personal financial planning, there are two basic things you will be concerned about. First you will want to know how much money you expect to spend on a monthly basis in the next budgeting period; which often is one year or twelve months. Next you will need to determine where you will get the money from in order to meet all your outlined monthly expenses and still have a surplus amount to save and invest to grow your wealth. If your total monthly income is not enough to meet your total monthly expenses; you will need to consider other alternative ways to bridge that gap.
The first option that most individuals and households have to help them in bridging their personal and household budget deficits is borrowing. This can be borrowing from other family members, friends or borrowing from the bank through bank overdrafts or applying for pay day loans. The most common borrowing however is the credit card debt that you accumulate when you swipe it at the retail shops and any other places you do shopping. Most individuals prefer using their credit cards since they give them the ability to buy more goods and services than their current cash balances cannot afford; as well as they get attracted to the allure of credit card rewards that can be redeemed later for actual shopping. What most individuals ignore however is the fact that if you do not manage your credit card use in a prudent manner, you might end up with a huge debt that might sink you into bankruptcy and your credit score will suffer in the process.
To ensure that you are not getting into the dark world of bankruptcy with a tainted credit score that will inhibit your borrowing in the future, you need to understand the kind of debt you take. There are two types of debts that you can have. The first type of debt is one that is used to finance your recurrent expenses such as the credit card debt and short-term borrowing to meet your urgent one-off financial obligations like paying school fees. The other type of debt is one that is used to finance your investment projects both in the short-term and in the long-term.
For the first type of debt, you borrow the money, spend it and repay it with an interest. In the end you are paying back more money than you borrowed, and you will need to look for another source of money to get the cash to repay the loan with. In the second type of debt, you are borrowing money, and investing it in a project that is giving you a higher rate of return than the interest rate on your debt. You then later on repay the debt from the proceeds of the investment project; after you have booked your returns from the same investment. In the second type of debt, you are using the borrowed money to generate more cash flows that exceed the value of the debt and its interest charge before you repay it. In the end you will have increased your net worth by the retained earnings from the investment project you funded using the borrowed money; and you will have repaid your debt comfortably.
To survive on debt sustainably, you need to take advantage of the power of leverage. This means that you will minimize the first type of debts as you maximize the second type of debt. However, when considering borrowing money to invest, always ensure that the rate of return from your chosen investment is higher than the interest rate on your borrowed funds.