The average person often hears about how bad debt is and that they should wipe out any they have as soon as possible. While there is indeed bad debt (when one owes money on depreciating assets), some debt can, in fact, be an invaluable asset when it comes to building and protecting long-term wealth. Financially savvy individuals understand how to leverage it effectively, potentially enabling them to take advantage of more opportunities and even create legacy assets. For many, it can be helpful to better understand the role debt management can play in establishing a solid financial foundation regardless of total net worth. In this article, we'll dive into the details of how the wealthy sometimes leverage debt to build wealth and see what we can learn.
How Can Debt Be Used to One’s Advantage?
Many wealthy people understand the power of debt and use it to create lasting wealth. How? They use debts, such as mortgages, margin and business loans, and credit cards, judiciously to invest in things that they expect will bring a return on their investment. In essence, as long as the return isn’t less than the interest they’re paying, they have made a beneficial decision. There is recognition that taking risks with their borrowing can pay dividends. Experienced individuals also use debt strategically by leveraging assets they already own to buy new ones. This allows them to expand their portfolios without using more of their own money. In this way, debt can be used as a tool for growth by those who understand its potential and know how to manage it correctly.
3 Ways Debt Can Be Used to Build Wealth
Let’s talk in more detail about a few of the ways debt can be used to potentially grow wealth.
- Real Estate
One way debt is commonly used to build wealth is to invest in real estate. When one purchases a property with a mortgage, the loan is typically for 80% of the purchase price, which means that they only need to come up with 20% (or even less) of the purchase price in cash. This allows them to leverage their capital so they can acquire more properties and grow their real estate portfolio more quickly. Even better if the value of the real estate appreciates over time.
- Leveraged Investing
There's an old saying that taking on debt is like adding fuel to a fire – it can increase the size of the blaze but also puts you at greater risk. When leveraged investing (we’re referring to margin trading here, not leveraged investment products) is done right, however, it can be a powerful tool for building wealth, as it allows one to multiply the returns of their investments. By using borrowed money to buy stocks or other investments, one can amplify the effect of market swings. However, leverage requires careful management since likewise any losses are similarly multiplied. It’s best used hand-in-hand with sophisticated risk management techniques to build wealth in a sustainable manner over time.
- Living Expenses
Using debt to cover living expenses is another strategy that can be beneficial when implemented properly. It involves using debt like margin loans or lines of credit to cover living expenses so one can invest the money that accumulates and/or avoid certain taxable events (like selling assets for capital gains). A high-net-worth individual might also strategically choose to pay off the loans they’ve taken out using sources that have more minimal tax ramifications. The key to success here is making sure one has the financial literacy and proper planning skills to manage this type of debt strategy.
While debt can no doubt be used to help build long-term wealth, it’s imperative that it is used responsibly and strategically. In order to make wise financial decisions, one must take the time to think through all of the available options. With enough knowledge and diligence, debt can indeed become an asset rather than a liability – if managed properly, it can be a powerful tool for increasing wealth. Individuals should reach out to a trusted financial advisor if they need guidance or resources related to leveraging debt — the right help and education can make all the difference.