The Fuss about Good Debt and Bad Debt

The Fuss about Good Debt and Bad Debt

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“We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care.”

– Warren Buffet, Billionaire Chairman of Berkshire Hathaway, Inc

I have been hearing the debate about good debt and bad debt for a long time. Several gurus have been talking about how good debt can make you rich and make you a billionaire, etc, etc.  Some may even propagate that without using debt, you cannot get rich, I completely disagree with this. The fact is, debt is a dangerous territory for anybody. No matter how experienced you are as an entrepreneur or as a money manager, debt is like walking on thin ice. I doubt if anybody can be completely comfortable with debt.

The reason I say debt is dangerous territory is because there are so many things that are not under your control, your business sales could suddenly get eaten away by new competitors, market needs could change, the real estate industry could collapse, your tenants could go bust and you may need to pay up the entire mortgage from your pocket.

I have been hearing some famous gurus talking about using debt to buy real estate and to keep leveraging that piece of property to buy more and more real estate. This is so dangerous and things can go wrong so easily. I strongly recommend against this. I have heard way too many stories about real estate deals going southwards and real estate entrepreneurs filing for bankruptcy because they over-leveraged their properties.

Gurus have been telling people from time to time that good debt is debt that puts money in your pocket and bad debt is debt that takes money out of your pocket. If you are using debt to buy a business, that is good debt, if you are using debt to buy luxuries that is bad debt. But the fact of the matter is, if you borrow money to start a business, how could you tell if it is going to put money in your pocket? I know most entrepreneurs are optimistic and have high levels of self-confidence, but the fact is several things are not under your control and you could be placing your entire financial life in jeopardy by taking a loan to start a business or even buy a property for that matter.

The next obvious question would be, how then should I start a business or buy an investment property when I don’t have any money in my bank account? You have a few options:

#1 Work hard, work over-time, work additional hours, get a second job, do some freelance work, sell something (could be a product or a service), save up some money and then start a business with part of that money.

#2  Partner with someone who already has the money and give him part of the earnings of the business. This way, you have part ownership in the business for your time and expertise while your partner(s) have ownership in the business for the money they have brought to the table. This could be a win-win situation for both of you.

When it comes to debt, the question you need to ask yourself is, is it worth it? To me, debt is just not worth it. I’d rather have no debt and sleep well at night rather than have a mansion with 100 million dollars in debt riding on it. If I need a mansion I will work hard, save up for it and then enjoy the fruits of that hard work.

Debt is too tempting and too dangerous a road to travel. I say tempting, because it is the easiest thing to do, you want a house – hit the bank and fill out an application, you want a car – hit the bank and fill out another application, you want money to start a business  – hit the bank and fill out an SBA application.

There are so many people in their 50s and 60s with loads of debt. It has always been that way for them, they have always had debt. They have never felt the lightness of not having debt. If that is you, then it’s time to change. Remember, it’s never too late to change.

“The financial calculus that Charlie and I employ would never permit our trading a good night’s sleep for a shot at a few extra percentage points of return. I’ve never believed in risking what my family and friends have and need in order to pursue what they don’t have and don’t need.”

– Warren Buffet, Billionaire Chairman of Berkshire Hathaway, Inc

I know a lot of people may have contrasting views and beliefs regarding debt. But this is my view and my belief – some of you may agree and some of you may dis-agree.

Let us know what you think in the comments section below.

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