Why there is no such thing as bad debt
Allow me to present a brief case about debt.
I want to make the case that all debt is good debt, if it’s used properly. Let’s look at some examples.
- A mortgage helps to build home equity, which is important since the majority of Canadians and Americans are home owners.
- A student loan is an investment in higher education. An investment in knowledge and human capital pays the best dividends.
- A credit card delivers instant gratification, which offers immediate value to the present, while delaying payment until later.
- A business loan helps a company grow faster which gives it an advantage over its competitors.
- A line of credit reduces financial risk, can pay for unexpected emergencies, & doesn’t incur any interest when not being used.
- A car loan can help finance a reliable means of transportation that will shorten the amount of time spent on the road, and increase the overall commuting experience.
It appears each time we borrow money, that debt helps us achieve our goals and aspirations in one way or another, so there is no categorical bad debt. 🙂 Borrowing money is not something to be ashamed of. It should instead be celebrated because the creation of debt is also the creation of money, which usually leads to economic prosperity. Welcome to the page that’s all about debt.
Debt in my life
Debt is simply a financial tool that can be used to improve the quality of everybody’s lives, as long as it’s used in moderation and responsibly. 😉 I have over $500,000 of debt today and I do not feel any stress from it. I know this debt is helping me achieve my financial goals. It would be difficult to reach early retirement without it.
However debt is often in serious disrepute because it can be abused or mismanaged. Without proper understanding of how it works, debt can consequently spiral out of control. But a free life-time supply of Starbucks Vanilla Lattes can be abused as well. Just because something may be detrimental to our well-being doesn’t mean we should eschew it. Debt itself is never the real problem behind overwhelming indebtedness. It is merely a symptom. The fundamental cause of that unwanted debt is most likely an unsustainable lifestyle of living beyond one’s means.
Debt as an Investment
In 2014 the Canadian government sold $1.5 billion worth of 50 year bonds. This means the Fed has borrowed $1.5 billion from investors and doesn’t have to pay any of the principal back until the year 2064. Until then the government can use the $1.5 billion to fix bridges, build infrastructure, create jobs for the unemployed, and invest in public goods and services that benefit every Canadian! The only cost to borrowing this money is a mere 2.96% annual interest rate, which is a bargain compared to the potential economic and social benefits this major investment will help to create for this country. The Finance Minister said these bonds will “reduce refinancing risk and lock in low-cost funding for Canadian taxpayers.”
If we know potholes and traffic congestion are costing drivers valuable time and money, and that old bridges need to be repaired sooner or later, and that we’re facing an inevitable demographic shift towards an aging population, then doesn’t it make the most sense to borrow money today to deal with these real issues? Let’s get ahead of the situation by locking in cheap financing at record low interest rates for the foreseeable future.
Everyone uses debt
Local communities use debt all the time to buy services and programs they can’t afford, but still want. In its 2012 budget, Mississauga, ON used debt to fund city projects. It borrowed $21 million to retrofit street lights with more energy efficient LEDs. This resulted in long-term savings based on reduced electricity and maintenance costs, with full payback expected in 6 years. That’s a pretty decent return on investment, which wouldn’t be possible without using debt.
South of the border, the largest wireless operator in the country borrowed $49 Billion in 2013, the most debt ever issued by a company. American oil and gas companies have also ventured deeper into debt in recent years, increasing their borrowings by 55% since 2010, to almost $200 billion today.
What happens to debt when interest rates are lower than inflation
Normally a mortgage is considered a liability. And bonds represent a low risk, low return investable asset class. But when real interest rates are negative you can throw those conventional concepts out the window. A negative real interest rate means fixed income investment returns can’t keep up with inflation. And this has overwhelming consequences for everyone.
In 2021 the rate of inflation is 3%. But mortgage rates are below 2%. This means you are literally getting paid to borrow money in real terms.
The value you pay to service a mortgage is less than the value inflation erodes away on that mortgage balance.
On the flip side, fixed income investments now come with an additional risk. In a negative real interest rate environment bond funds are yielding below the inflation rate. This means the distributions to unit holders can’t even keep up with the rising cost of living.
Why is this significant? Because it means typical bond funds today will actually have a drag effect on a portfolio. So anyone who has a traditional 60/40 balanced portfolio should really reconsider their positioning.
That 40% bond allocation is dragging down the returns on the rest of their portfolio – slowly eating away at the investor’s wealth. This makes bonds liabilities, not assets.
And yet somehow when it comes to personal finance, all we seem to hear are suggestions on how to get out of debt, ways to be debt free, and why debt is always bad. But money and debt does not discriminate. The free market rules that govern the budgets and finances of governments and companies also apply to individual people like you and I. The average consumer who claims to be debt adverse also complains he is no further ahead financially than where he was 5 years ago. Meanwhile those who incorporate debt into their financial plans like millionaires, politicians, investors, governments, and businesses, have all done fairly well for the most part.
The good news is anyone can use debt to get ahead. Home owners can dip into their HELOCs to finance capital intensive projects such as a kitchen renovation or investing in an income growth fund or shares of a profitable business. Maybe it’s time for the 99% to start looking at debt as a tool for prosperity rather than a plague to avoid at all costs. And like any other tool, maybe all we need is to learn how to properly use it. But not acknowledging debt for its full potential would be a missed opportunity that we can’t afford to pass up.
Further reading about debt:
Debt leads to economic growth – How debt creates money
The Debt to Income Ratio exposed – Not a reliable way to determine financial debt burden
The Rising Cost of Education – Tongue in cheek commentary on the state of modern day millenials
Coping with Debt – Looking at debt from the big picture
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What a breath of inspirational fresh air.
What about that person who is debt free he can change the world in good ways, with out living with a bomb in his bank account that could go off at any time. you are living on borrowed time.
Money we hold in our wallet and in our bank account is a debt .. In fact the dollar bill a.k.a. the Federal Reserve Notes are legal tender, with the words “this note is legal tender for all debts, public and private” printed on each note.”
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Great post! Very interesting read.
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When you say “those who incorporate debt into their financial plan… have all done fairly well for the most part” that is not accurate. You are not accounting for the risks associated with the debt. If you lose your job, and can’t pay your mortgage, you have a fall-back position of moving n with your parents. Many other people, due to their circumstances, don’t have a similar safety net. For them, taking on debt can be like walking a tightrope without a net. You might be all right, but then again, you might not.
During the recession, 100% of foreclosures happened to homes with mortgages. Zero to homes which were debt-free.
Folks, you need to be careful reading articles like this. The author does not give adequate attention to the risks associated with high leverage.
If you read through the articles on this site, you might get the impression that buying real estate and other assets using vast amounts of borrowed money is a reliably successful strategy for building wealth, one in which the potential benefits far outweigh the risks. The reality is that this is often not true.
The author’s life experience is the exception, not the rule. He (like me) lives in Vancouver, a city which has experienced double-digit price increases in the real estate market year after year. Farmland has risen as part of this general trend. The author bought into this booming market with a of debt, so it is obvious that he made money doing so. But the point here is that his experience wilo nt necessarily be repeatable for you. Indeed, it is probably not even repeatable for him and I! (The Vancouver prices have started to taper off recently).
It’s the same story with respect to his stock investing. He bought shares at the bottom, following the 2008 financial crisis. So did I. Obviously people who bought at that timr made money doing so, and using leverage at that time would have paid off. But if you take away the lesson that “leverage always pays off”, you’d be setting yourself up for disaster! The truth is that when you examine the sources of the author’s success, it has been mainly a result of luck/timing.
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