The first time I saw debt as two distinct types, that is ‘good’ debt and ‘bad’ debt was when I read Robert Kiyosaki’s “Rich Dad, Poor Dad”. For me it just seemed to click as till that point, I had used debt for a range of things – to build a home, buy a business as well as a personal loan, overdraft, car loan and credit cards. It really was all just bundled together under the umbrella of debt as it would be for many other people especially if in your own small business.
What Robert did was talk about this split concept, in not only defining the difference but also what the ultimate goal was in how to use debt to your own advantage in building real wealth.
He put in bluntly in that “The rich use debt to make them richer, and the poor use debt to make them poorer”. On a sidenote, this is also a sad indictment on our society as we now have such easy access to “bad’ debt with credit cards and Buy Now, Pay Later schemes such as Afterpay. Afterpay which only makes money it seems if people default and therefore pay fees (and now Banks are coming out with their own versions), same with credit cards. So, it is a major problem and the sooner more people learn how to use debt to their advantage the better (I will get off my soapbox now).
So let’s define these terms.
Good debt is debt that provides the funds to buy assets such as shares and property, that provides growth on the asset, as well as an ongoing income stream. Borrowing for your own home is the only caveat to this as you need to live somewhere and who wants to pay rent.
Bad debt is pretty much all other debt such as credit cards or personal loans. Debt to buy things that usually lose value over time such as cars or clothes, and doesn’t provide an income stream.
How you can use good debt to your advantage?
Good debt allows us to buy good, income-producing assets, the value of which outpaces our ability to save for them. What I mean by that is say you want to buy a $500,000 investment property today but only have $100,000 to spend. By the time it takes you to save the remaining $400,000 – let’s say 10 years – the property’s value has risen to $1 million. It is even further out of reach.
In contrast, if you used your $100,000 as a deposit and borrowed the $400,000, you could buy the property today and take advantage of that capital growth, and the rental income, over the next 10 years.
Borrowing for property investment is a common example of good debt. First, the debt is attached to an asset – the property. If it’s a good property it will appreciate in value over time. Second, that property will provide you with a regular income in the form of rent. It’s that income stream that is the hidden gem of good debt.
Another example would be borrowing to buy good quality shares. When you buy shares, you are effectively buying ownership of a part of the company such as a bank (I would much rather own the bank – even if only a small part – than owing money to them with a credit card). When the company earns a profit, you receive a yearly dividend (usually paid twice yearly), another type of income stream.
So why is it good to have income producing assets?
Well the main aim of being wealthy or even just to ensure you have financial freedom, is to ensure you have enough assets to provide an alternate income to salary so you don’t ever need to work again (earn money while you sleep as they say). It’s fine if you do want to keep working but importantly you are now doing it because you want to, rather than you have to.
This is particularly important for members of the sandwich generation as this easy ‘bad’ debt is targeted at their millennial children. So helping them understand the difference will help them to use good debt to their advantage and help set them up for life.
While credit cards and such will always be a part of our life, the key to successful debt management is to use good debt as a tool to build assets, while minimising the negative effects of bad debt.
Good luck on your own Money Sandwich journey.
Article by Marc Bineham – Money coach, speaker and award-winning author of The Money Sandwich