This might sound counterintuitive, but you can use debt to become financially independent. Now, this doesn’t mean you should run out and max out your high-interest credit cards or go on that trip you can’t afford. In fact, the exact opposite is true as getting rich through debt requires an financial intelligence and isn’t exactly for the faint of heart.
However, if you understand how debt works and can build structures that are ‘anti-fragile’, then read on as this article will explain how debt can help you to become financially independent.
Rich Dad & OPM
If you are familiar with the writings of Robert Kiyosaki, then you know the rules of how to create and sustain wealth. One them is OPM – Other People’s Money. While this sounds fancy, it means borrowing.
Let’s get things straight, wanton indebtedness is bad. In fact, it is the leading cause of financial stress for most people. Car loans, home mortgages, second mortgages, student loans, credit cards, medical costs. This accumulation of debt has created a modern form of slavery; one where you work and everything goes just to service your existing debt.
Unfortunately, many people live with the realities of this type of debt and for that reason, they often feel helpless when it comes to managing their finances. But there is another form of debt – good debt. This is debt that you take on to help you create wealth.
This could be in a lump sum loan which then helps you purchase an asset which will deliver a real return or it could be a financial instrument which helps you to get paid today for a slight transaction fee. This is often how rich people use debt and if you are serious about helping your family to become financially independent, then this is how you need to start using debt as well.
As mentioned, using debt to create wealth requires a certain level of business acumen. Not only do you need to know the ins and outs of the debt that you are looking to take on but you also need to know to properly analyze the investment you are considering pouring the money into.
If you can do this, then you will be able to build wealth fast(er) than just relying on paying cash for everything. A lot of this comes down to what is known as the time value of money (TVM).
In simple terms, this is the concept that the money available to you today is worth more than the same amount of money in the future. As such, being able to access money, at reasonable terms, today to purchase an asset effectively lowers the cost of that asset in the future. In turn, this increases the future value of that asset and by extension your return on investment.
Granted, this is a somewhat simplistic analysis but the point is that $1 today will be worth less in the future while using OPM to purchase the right asset will yield outsized returns in the future.
This is basically what we do when we purchase a house – though some analysts would question whether this is a good investment. The reality for many is that buying a home is not a good investment as it is usually highly leveraged and does little to increase how much cash you have in your pocket.
As such, a better real estate investment would be purchasing a multi-family home in an area of the country which is well positioned to withstand economic uncertainty at a good price, and then making sure you keep the property occupied. This is one reason why investments in student housing have performed well in recent years.
Let ‘Good Debt’ Work for You
An example of ‘good debt’ would be taking out a loan to purchase several investment properties, as opposed to paying cash for one property. By using the bank’s money, you are not only able to take possession of multiple revenue generating properties – thus, putting more money in your pocket – but you are also able to keep most of your money.
Sure, you will have to pay the interest on the loans and depending on the cash flow, you might want to accelerate the mortgage payments but owning multiple investment properties helps to diversify your risk. In doing so moving you closer to the goal of financial independence.
Good debt also helps you to increase your return on capital and this is a big reason why the rich keep getting richer today