Learn why using responsible debt in your investing strategy can be critical to helping accelerate wealth.
At one point or another throughout your life (likely more than once), you've been told that debt is a bad thing. Your parents probably used to say "going into debt is irresponsible" or "going into debt will make your poor." Statements like this are not necessarily inaccurate as much as they are incomplete. Using debt responsibly can be one of the most fundamental ways to help build wealth in business and personal life. Perhaps this is a counter-intuitive idea for some - how can going into debt make me more wealthy? Let's dive in.
A Brief History Lesson
For the vast majority of the United States' history, as well as other countries', our financial system was denominated in gold. Put simply, this meant the dollar bills you physically held in your hand were redeemable for gold. Paper bills made it much easier to transact and transport as opposed to physical coins or bars. But in the early 1930's, as part of FDR's New Deal, U.S. citizens were forced to sell back all of their gold to the government, and dollars would no longer be redeemable for the precious metal. The reason, according to President Roosevelt, was that hoarders of gold were hurting the economy.
By 1944, the United States' government was the proud owner of 80% of the world's gold stock. In the decades following WWII, a lot more money printing & government spending occurred. Fast forward to the 1970's - as international trading partners wanted to trade their dollars for gold, the government started running lower & lower. Because even though U.S. citizens could not exchange dollars for gold, these dollars were still denominated in gold for our international trade partners. So in 1971, President Nixon "closed the gold window", which in effect disconnected the U.S. dollar from gold for good.
Okay, so why am I sharing this?
The Financial System is Debt
Today, if you look at any U.S. paper currency, be it a $1 bill or $100 bill, you will see the words "This note is legal tender for all debts, public and private." The key word to focus on is note.
Well, what is a note? A note is a loan, and as an individual holding a note, you are the one who is owed. So, who owes? The Federal Reserve does. However, as we learned above, that's no longer possible - the "window" is permanently closed. This concept highlights the fact that our entire financial system is underpinned by debt.
When our currency isn't backed by anything real, what stops the Fed from printing dollars uncontrollably? In periods of staggering inflation, much like we've witnessed in 2021 and 2022, it makes you question what parameters are in place.
Using the Information
Everything shared above is to illustrate the fact that (1) inflation is a reality and (2) debt is the financial system. With these rules in place, you have to play the game with them in mind. Robert Kiyosaki says "savers are losers." What does he mean by that? If inflation is 10% and you have $100K in the bank, you're burning $10K just by letting it sit.
When inflation is soaring, using as much debt as possible to purchase productive, cash-flowing real estate, benefits you in a couple of ways. First, you're not allowing your money to remain stagnant. Second, debt from your lender is helping you purchase assets that you could not afford with your own money, and these assets produce income for you.
If an apartment building costs $1MM, you bring $250K to the table alongside a partner. It's a 20 unit property producing $100/unit/month after you service the debt, which equates to $24K in cash flow annually. That turns out to be 9.6% cash-on-cash return ($24,000 / $250,000).
Lastly, and something that is too often overlooked is your "debt debasement". This concept is perhaps the most powerful as it relates to building wealth, assuming you are accumulating responsible debt that can be serviced, even when times are hard. I also write about this in my Beginner's Guide to Multifamily Investing. If you have $1MM in debt and inflation is running at 10%, you have a $100,000 tailwind, assuming your debt is fixed. This "tailwind" is known as your debt debasement.
Consider your personal residence as a relatable example (although your personal residence isn't an income-producing investment, a 30-year mortgage on a fixed rate drives home the point). Imagine 25 years ago, you took out a $500K loan to purchase your home. $1 in 1997 is the equivalent of $1.82 in 2022 - a cumulative increase of 82%. Applying that to your $500K loan balance, this equals out to $410K. In other words, just by holding the debt for 25 years, inflation over time is helping chip away at the debt - $410K of your $500K obligation.
Not to mention the fact that your home value has nearly tripled in that time!
Now take that a step further and consider income-producing real estate, like Multifamily investments, where you have tenants paying your mortgage for you. Not to mention rents steadily increasing year over year with inflation. Starting to connect the dots?
Obtaining as much responsible, income-producing debt that you can get your hands on is a winning formula, proven time & time again by real estate investors. When possible, locking debt in for long periods of time at fixed rates not only provides peace of mind, but also benefits from inflation. It's one reason our government secretly loves periods of high inflation due to the staggering debt volume they have on their balance sheet.
Hopefully this article helped illustrate why debt isn't so scary, and how it can be critical to helping accelerate wealth when having it be part of your investing strategy.
"Real Estate is actually a liability. It's your debt that is the asset." - Anonymous