“The more debt I have the richer I get”
It’s easy for the Irish to build wealth, because their capital is always Dublin. But the rest of us have to find others ways to grow our net worth. I recently listened to an episode of Palisade Radio, where the host, Collin Kettell, interviewed Robert Kiyosaki, an American investor and the author behind the Rich Dad Poor Dad book series. According to Robert, one way to build wealth is by using debt. Here’s a part of the interview.
“People think I am a real estate guy, but I am not. Really, I am a debt and taxes guy. You see, the more debt I have the richer I get, and the more debt I have the less taxes I pay…. The 1% does not pay tax. They are also deeply in debt, but it is good debt – debt that makes them rich.” ~ Robert K
I currently have $490,000 of debt. If Robert K. is correct then maybe I should borrow even more money so I can become financially independent sooner, haha. But in all seriousness he does bring up some interesting points. Borrowing money allows us to invest more than what we currently have in savings. This magnifies the returns or losses of our investments depending on how they perform. He also suggests that having more debt leads to lower taxes. This can also be true. For example if we buy a rental property with a 20% down payment then the interest we pay on the mortgage debt can be deducted from our salary which will lower our taxable income, which means we pay less tax. 🙂
Robert is also not a fan of the 401(k), which is similar to the company matching RRSP program in Canada. He believes it’s basically another kind of tax. For example an American worker may put $100 into a 401(k) and their employer will supposedly “give” them another $100 for free. But Robert argues that this reasoning is bullocks because it’s suppose to be the worker’s $200 in the first place because it’s part of the cost to keep someone hired. “The company isn’t doing you any favors,” he claims.
“…They basically take your money before you get paid, and the poor, small worker, I feel for them. They do not have any idea what is going on. … It is basically a Ponzi scheme… Old guys with 401(k)s are starting to withdraw their money. How is the market going to go up when the money is coming out?” ~ Robert K
Although he makes some good points about the benefit of using debt to get ahead, there are also risks involved with borrowing too much money, especially when the money is poorly allocated. My friend Bridget from Money After Graduation has an MBA and she warns about the commonly forgotten risk of borrowing to invest.
Rate is Associated with Risk
She uses the example that we can choose between either paying off our student loan debt at 2% annual interest rate, or invest in the financial markets where we can reasonably expect to make 5% a year. At first glance investing seems to be the smarter choice because there’s an easy 3% gain to be had due to the difference in rates, a.k.a. arbitrage. 😀
But hold the ham sandwich! Bridget suggests that this isn’t the case because the rate of return is usually equal to the same level of risk. Normally if we buy a stock that pays 5% we have to assume the amount of risk that is appropriate for a 5% return. But if we’re borrowing to invest, or could be using the money to pay down student loans at 2% instead, then the actual risk we’re taking on is 7%, due to the extra 2% opportunity cost associated with our debt. Does it make sense to risk 7% for a 5% market return? Probably not.
I think both Robert and Bridget make some convincing arguments. Isolating certain issues about taxes, risk, and employer matching retirement plans make things easy to understand. But real life can be all sorts of complicated and we have to consider many factors in order to build a compelling financial plan for ourselves. A helpful way to determine if our financial decision is good or not is to explain it to other people. If we can’t convince our friends that we have a solid plan, then we should probably take another look at our decision. 😉
By the way, there’s a new reader’s poll on the right sidebar of the page. I look forward to the results so I can provide more interesting content. 😉
Random Useless Fact:
French people everywhere are going nuts over this bag-uette.