The Power of Debt

Scroogey greetings to all of you and here’s wishing that 2010 will be a better year if 2009 had not been. And since its the first Scroogey post of the year, Aunty Scroogey thought it will be great to start off with something positive. How about talking about the power of debt?

Debt? Positive? You must be thinking – did something go wrong somewhere? How can debts be considered positive? Ah well….. that depends on what you do with the debt. You see, financial debt is a very powerful thing; and its a double-edged sword. It can crush you and take over your life or it can help to make you rich. VERY rich.

If you’re a guy, think of it as a razor blade, which you can use to shave unsightly stubs and make yourself look clean shaven and attractive. But if not careful, you could cut yourself and end up with a scar. Same goes for debt. If you take on credit card debts or other form of financial debts as a means of financing (meaning you don’t pay in full when bill is due) for consumption such as buying new tech gadgets, branded goods, travelling, etc, then that’s akin to cutting yourself with the razor blade.

However, it’s a different story if you use debts for making a good investment, that is, acquire a good asset that generates enough recurring cashflow to service your debt and at the same time, provide you with positive leftover cashflow. Eg. a vending machine with remaining life of 12 years costs $5,000. You put $1,000 as a downpayment and finance the balance $4,000 with a 3-year loan that charges you 8% per annum, making loan repayment just under $140 per month. Total takings from the machine averages $400 a month, and servicing costs is $500 per annum. Assuming no other costs, your net cashflow is $2,620 per year.

The above example has been made simple to show you the use of debt to help increase your cashflow. The additional cashflow of $2,620 is only from 1 machine, but assuming that you have 10 of the same machines averaging $400 sales a month, it works out to $26,200 a year. A vending machine might not have any upside potential (meaning sell it at a higher price), but if the asset in question is a piece of real estate that not only gives you positive net cashflow every month, but also the chance to sell it off at a higher price down the road, would you still think of having debt as a negative thing? In fact, this is exactly how the rich gets richer – that is, with the help of debt.

A young lad whom The Aunty spoke to recently said he wanted to be a real estate tycoon when he reaches 50. And I asked how does he plan on achieving that? He says he will start by buying the tallest office building in the central business district. I told him those things cost lots of money (something like a few hundred million) and he says it doesn’t matter, he will save till he has enough to buy.

Ahem…. assuming he is going to save $20,000 a month (errr…..yeah I know, but let’s assume shall we?), he will need to save for 10,000 months or 833 years just to buy an office block that costs $200 million. I am dead sure he won’t live that long. And we have not even factored in inflation yet during that 833 years.

While it may sound like getting a loan to finance a good asset providing decent cashflow sounds like the sensible thing to do, one must not simply jump into it without the use of a secret weapon – that is, financial knowledge. Remember, debt is a double-edged sword. I can’t emphasize enough how important it is to equip oneself with the necessary financial knowledge in order to use such a powerful tool. In the real word, lives have been lost, businesses folded up and families torn apart when people who do not have adequate knowledge use the sword wrongly.

How about you – is the debt you have making money for you or do you fall on the wrong side of it? How about setting a new year resolution this year to start your financial education if you have not done so? Regardless of what profession you’re in, a financial education is useful when it comes to planning your own financial journey.

Here is an interesting video to summarize what Aunty Scroogey wrote in this blog entry.

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About admin

I hail from a little red dot on the South China Sea call Singapore. Am an extroverted introvert and notorious for nothing and everything. I often suffer from logorrhea so please do not take what I say too seriously.

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