The one thing that keeps many people stressed and anxious at night is not a lumpy mattress, excess heat, extreme cold, or getting chased by a ghoul in a dream.
According to a new Capital One CreditWise survey, 73% of Americans rank their finances as the №1 stress in life, ahead of politics (59%), work (49%) and family (46%).
The study also reveals that younger generations are especially stressed out about their finances than older generations, with most Gen Z’ers (82%) and millennials (81%) saying finances are somewhat stressful.
But hear this. Not all debt is created equal.
True, some people will tell you never to take on any debt, and that’s their opinion, and it’s okay. But I feel that there are two sides to debt, good and bad.
With that in mind, in this article, I’ll be telling you about good debt vs bad debt.
The best part? I’ll let you in on how you can invest effectively in yourself with debt.
We need to begin today’s article with this — you should always do whatever it takes to get out of debt, good or bad. Debt is debt, and it comes with risks attached to it.
With that point emphasized, the conventional wisdom goes that good debt is the one you incur for things that are expected to increase in value over time, thus increasing your net worth.
On the other hand, bad debt is essentially borrowed money that does not attract any returns over its lifetime and hurts your net worth. Think of it as spending on something that will depreciate.
Now, Let Me Give You Some Examples to Help You Tell the Difference Between Good and Bad Debt.
An investment mortgage you take to flip houses or purchase them for the sole purpose of renting them is an example of good debt.
According to Robert Kiyosaki, author of the famous Rich Dad, Poor Dad personal finance book, it’s better to use a mortgage to invest in rental properties, which are great examples of assets since they’ll undoubtedly bring money into your pocket.
As for bad debt, I think the worst kind is any borrowed money you use on anything just for showing off.
Think of an expensive car loan you take just to give the impression of success without considering its maintenance fees and the fact that a car dramatically decreases in value over time.
Referencing Robert Kiyosaki again, he classes any student loans you take as bad debt unless you are 100% sure of graduating and what you will study in college.
I agree with his idea since if you drop out of school or graduate only to discover you don’t want to be in the field you majored in anymore, you’ll have racked up debt for nothing, and there’s no escaping it.
Keep in mind; a student loan is the only type of debt you can’t avoid by filing for bankruptcy if you are in the US.
Good & Bad Debts
Moving forward, appearing on both good debt and bad debt lists are credit cards.
They are considered bad debt when the things you put on them attract interest without giving you a higher return than the interest rate, think paying for a fancy dinner, a trip to an exotic destination, and so on.
Still, credit cards can be good debt if you can pay them off monthly for the sole reason of enjoying the reward benefits, e.g., travel packages, gifts that you can exchange with your credit card points, and of course, a better credit score.
It’s also good debt if you spend the money on something that yields returns at a higher rate than the interest charged on your debt, for example, a high-yield savings account and CDs (certificates of deposit).
Business investment loans are also good debt if you take them to grow your business.
While I am on this point, I’d also like to advise you that you shouldn’t take on debt to start a brand-new business.
Personally, I feel it’s risky since you have no clue whether the business will do well.
You are better off starting a new company with your own money or capital from willing investors.
If you have to, be sure to take on loans under your company’s name (if possible) but not yours to avoid hurting your credit score.
Let’s Now Talk About Financial Leverage — Creating Good Debts to Multiply Your Returns
There are many ways you can use debts to finance investments, which is especially practical if you live in a destination where the interest rates on your debt are pretty low, for example, in Hong Kong, where the interest rates can be really low to an APR of ~1.5%.
That said, let me briefly walk you through 5 ways debt can help you make more.
Margin investing: This is when you borrow money against your stocks from a brokerage firm to purchase more stock.
Leveraged ETFs: A leveraged ETF (exchange-traded fund), which holds both debt and shareholder equity, uses the debt to amplify the daily return to shareholders.
Hedge funds: These are actively managed alternative investments that typically use non-traditional and risky investment strategies or asset classes. They are famous for generating abnormal returns by using leverage.
Short selling: This is where you bet against particular security by borrowing shares from an investor and selling them in hopes that the shares decline.
Forex trading: It allows you to control large blocks of currencies with a small amount of money. You can lever up your account 100:1.
The idea here is that your return on investment (ROI) should be higher than the interest payments on the debt you’re acquiring.
If You Wish to Acquire Good Debts, Here Are the Steps to Follow to Start Off On the Right Foot.
Step 1: Educate Yourself
Learn as much as you can on debt to know how to use it without impacting your life negatively.
Consider finding a mentor who has done what you are looking to do before.
Did they use debt successfully to grow their business? If they did, learn from them.
Educating yourself on debt is also vital in ensuring that any good debt you take on stays good.
After all, your good debt can always turn into bad debt.
Step 2: Stop Accumulating the Bad Debt
Another great way to invest in yourself is to avoid accumulating bad debt.
It means cutting down your expenditure on things that depreciate rapidly or for consumption.
Examples include spending debt on designer clothes, automobiles, and that bad boy 80-inch UHD TV you need to watch NFL games.
While still on this, here’s a tip to help you stop racking up bad debt- start sacrificing some things and delay your gratifications.
For example, you could delay your purchase for 30 days and ask yourself if you will still remember this purchase three years later.
Step 3: Start Paying Your Bad Debts
It might not seem like it but repaying your bad debts is a great way to invest in yourself.
It helps you improve your credit score, increases your chances of accessing more loans (i.e., good debt) in the future, and gives you the peace of mind to focus on other self-development matters.
So, please make a list of all the bad debt you owe, whether to friends, family, investors, banks, etc. and start paying it off.
Step 4: Have a Repayment Plan Before Taking any Debt
An excellent way of managing your (good & bad) debt situation is to lay up a repayment plan before taking on any of it.
You want to understand the interest on your debt, the duration you’ll need to repay it, and so on to be in a position to accommodate any eventualities beforehand.
Some good books to help you learn how to repay your debts include I Will Teach You to Be Richby Ramit Sethi, The Simple Path to Wealth by JL Collins, and The Millionaire Next Door: The Surprising Secrets of America’s Wealthy by Thomas Stanley.
Step 5: Take the Bare Minimum of Debt
Even if that’s good debt, you want to make sure that you keep it at the minimum. It means that if your business needs $1,670 to achieve the next milestone, you can take on a debt of the same amount. Don’t go for $2,000.
I hope this article has helped you understand what is good vs bad debt so you can decide whether to leverage debts as a tool for growth.
Perhaps what I want to stress the most in this article is this — taking on debt isn’t the problem; the real issue is failing to learn about it and not managing debt well.