Saturday, May 16, 2009

Debt is a good thing (in moderation)

Many people rant about the negative aspects of being in debt. Where the debt has been racked up to fund an unsustainable lifestyle (overly large mortgages, credit cards with carried balances, payday loans etc), viewing debt as an absolute bad thing is, perhaps, understandable.

I do not share that view. In most cases, the culprit is not the debt but the decisions which led to the debt being incurred. I view debt as a wonderful tool for promoting wealth creation. Here are some examples:

1. borrowing money to finance successful investments can greatly enhance returns. For those with an eye on early retirement, using leverage can add years to the time spent doing more meaningful things than sitting in an office cubicle;

2. credit cards provide a wealth of convenience - saving many trips to the bank or ATM, reducing the costs of spending in foreign currencies, discounts, points etc. And they cost nothing;

3. student loans can fund an education that would otherwise be unaffordable;

4. governments around the world would not be able to afford the stimulus packages they are currently implementing (of course, if they had wasted less of the tax payers money in the good times they wouldn't need to borrow nearly as much).

The other big benefit of debt is that debt enables investors to put money on deposit with banks and buy bonds, CDs and other interest bearing instruments. If debt did not exist, then neither would any of these forms of investment - and for most investors, deposits, CDs and bonds are the least risky part of their investment portfolio.

Of course, unless you are a civil servant, there is no such thing as a free lunch. Debt has a cost (interest) and comes with an obligation (to repay it). Without the interest cost and the obligation to repay, no one would lend money.

As much as I like debt and view debt as a positive thing, the obligation to pay interest and to repay the loan mean that too much debt can be dangerous. In some respects, borrowing money for investments is a bit like drinking red wine: a little is good for you - too much can be detrimental to your (financial) health. The latter is a point that governments who are busy racking up massive amounts of debt should pay more than lip service to - at some stage the money has to be repaid.

1 comment:

RM_Apply said...

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