Does it ever seem like the wealthy have some secret formula that’s hidden from the rest of us? Well, lean in close because the best kept secret of the rich is a single word: Debt. That’s right — you don’t have to own any money to make money, if you’re smart about it. Yes, let us understand good debt vs bad debt.
Just look at all the businesses affected by COVID19 and how much harder it was for those with lots of debt. Oh, you’re talking about BAD Debt – and yeah, BAD debt is bad, it’s in the name. I’m talking about that sweet, “good” flavor of debt that accelerates dreams and opens doors. Wait…there’s good debt vs bad debt now?!
Oh, and of course there are the worse “good debts” and better “bad debts”. Debt might seem like a relatively modern phenomenon, with stories of national deficits and credit card balances dominating the headlines. But debt is a very, very old human invention. Writing was invented in ancient Mesopotamia in order to keep track of debts. In fact, debt even predates the invention of money. Wrap your head around that! In his book “Debt: The First 5,000 Years”, David Graebner of the University of London argues that it was debt, not physical money, that made economies hum for thousands of years.
Debt made civilization possible.
Debt made civilization possible, really, by allowing us to track who owes what to who more easily than physical bartering. And the seemingly modern urge to run away from our debts and live a simple life in the wilderness might also be an instinct as old as society itself. Graebner writes, “People would just start running away, joining nomadic bands and periodically kings would declare debt cancellations.” It’s really not that hard to see why we have such a love-hate relationship when it comes to debt. It can help you achieve your goals much faster– like a small business loan to open up your dream bakery, or a student loan to help you pay for graduate school.
But, when things get dicey, it has the annoying tendency to make us become the star of our own production of “Naked and Afraid.” Conventional wisdom goes that good debts are incurred for things that are expected to increase in value over time – think a house or small business. Bad debts don’t — like a trip to Cancunor a fancy dinner. While most of us may have a few “bad debts”, experts generally agree that those debts limit your ability to build wealth. But from there, things get complicated. You might’ve heard media personalities take strong stances on the use, purpose, and even existence of “good debt.” And two of the loudest modern voices in this debate have been Robert Kiyosaki and Dave Ramsey.
Rich Dad about Good Debt vs Bad Debt
In his bestselling book “Rich Dad, Poor Dad”, Kiyosaki claims to have learned critical financial lessons from a friend’s father, aka his “Rich Dad”. Such lessons included the value of education, the power in working for yourself, and the importance of always investing with Other People’s Money. He writes” Good debt helps you get rich, Bad debt makes you poor: If you want to get rich, load up with ‘good debt’.” Good debt, in his view, is a way to build something out of nothing, and it’s allowed him to build a massive real-estate portfolio and multiple businesses.
Critics of Kiyosaki point out that he’s “good-debted” himself into bankruptcy on a few occasions. And that it’s mighty convenient that he sells real estate courses and speaks to multi-level-marketing companies like Amway, both of which stand to profit if audiences use debt to “buy in to the opportunity.” In the other corner we have Dave Ramsey, who preaches that a “good debt” is an oxymoron. Ramsey’s syndicated radio show opens with the tag-line “Debt is dumb, and cash is king.” He advocates that having no debt of any kind- including a mortgage – is a hallmark of success. This makes sense in light of his personal story.
In his mid-20’s, Ramsey had built a multi-million dollar real-estate portfolio, purchased with mortgage debt. When the bank called all of his notes at once, he went from millionaire to filing bankruptcy fast enough to make your head spin. Now, he has a similar view of debt that someone recovering from substance abuse might toward drugs or alcohol. Ramsey has his share of critics, too. For starters, they point out that buying a house without a mortgage is nearly impossible for most people. Indeed, Ramsey has a mortgage company advertise on his show!
Good Debt vs Bad Debt
Skeptics also argue that debt can be harmless if used carefully. Like using a credit card to receive points and paying off the balance in full. And for those with a low-paying job, trying to survive an emergency without any debt often isn’t realistic. We’ve personally found ourselves on both sides of the fence. We used to have a pretty friendly relationship with debt, both the “bad kind” — financed cars, credit cards with balances — and the “good kind”. After a few years, we decided to pay off all our debt except our mortgage and went almost seven years without using a single credit card.
Recently, we’ve evolved to utilizing credit cards again, while always paying the balance off in full every month. But what we’ve learned in the past decade of financial work is that answering this question isn’t usually solved by running the numbers. How you decide to interact with debt mostly depends on personal values and tolerance for risk. We came up with our stance by answering two questions.
First: How does your spending change with debt?
We’ve found we tend to spend more on a payment plan vs. paying for something in full. Indeed, research suggests that for most people, it’s natural to let spending creep up a bit if it’s purchased on debt instead of in cash. To paraphrase Socrates, “Know thyself before choosing the installment plan.”
Second: Is the risk worth the reward?
The benefits from using debt can be life changing. But debt always carries risks. When opening a small business years ago, we considered taking out a small business loan. But the risks seemed bigger than the possible reward of fast-tracking our venture. We opted to grow slower, but with less risk. In the end, Debt isn’t “good” or “bad”. It carries risk, but it can open doors. The “right” approach toward debt is ultimately personal and specific to your situation. But proceed carefully, remember there is no free lunch, and take things slowly so you can learn as you go.