Rethinking Debt and Chasing Yields: How to Use High Level Economic Concepts in Low Level Personal Finance
One of the paradigm shifts that took place as I began my journey as a real estate investor was my relationship to, and understanding of, debt.
Prior to this, debt was not something I looked favorably on.
I grew up poor, with a father who deeply feared debt and attempted to live his life paying only for things he could actually afford. A noble aspiration. I was taught that debt was something people fell into and was the ruin of many. If you didn’t owe anybody money, they couldn’t demand anything of you. Or such was the logic.
My formative adult years were spent in the throes and subsequent fallout of the Great Recession. The post-recession years gave rise to Dave Ramsey and Suze Orman, who preached, “Stop spending. Pay off your debt. Don’t acquire new debt. Save money.”
Being that one of the significant contributors to the Great Recession was rampant and negligent consumer spending, these gurus offered a message that many people needed to hear: “Debt is bad! Get out of debt!”
Additionally, my political and economic worldview greatly influenced my—predominantly negative—view of debt. Long before I was interested in personal finance and investing, I was interested in macro (large scale) economics; how did they make the world go around and affect society and politics as a whole? Though my politics have changed a great deal since I was young, early on I adopted a position that economics were the single most important topic regarding nation states, and that money was the most integral part of it all. (That thesis has not changed by the way.) Having a fiscally conservative worldview, I was appalled by the rampant government spending of the last quarter century. The national debt, the deficit… It blew my mind that the leaders of this country (and others) could spend money so recklessly, with no regard for the disastrous implications that even a layperson like me could see lie ahead. So much debt How are we ever going to pay back all this debt!
(Note: The first draft of this article was originally written in 2019, BEFORE the COVID shutdowns and the NINE trillion-plus dollars (and counting) in new money creation by the Fed and the Treasury. AKA: Quantitative Easing: Infinity Mode.)
My path to understanding economics/debt was the opposite of many. I first became interested in macroeconomics while studying statecraft and the nature of government, before eventually circling back to microeconomics and how the world’s monetary policy actually affects personal finance. I understood some high level concepts, but I knew that if I wanted to make money I would need to learn the practical application of said concepts. In order to do that, I had to take moral analysis out of it and use a more pragmatic approach. At this point, I had gone even deeper, and had begun to understand that the game was rigged. Mountains of debt, inflation, currency manipulation… These weren’t accidental byproducts, they were intentional techniques used by those in power who stood to profit from them. Okay, I get it, Daniel… But HOW?
In a moral monetary system, debt has limited value. Saving and acquiring currency is the focus. But in the era of central banking, debt is a tool. We are a debt economy, and thus debt is a currency. I came to realize that the rich and powerful use debt to accelerate the growth of their holdings. This differs from how the poor and middle class use debt in two distinct ways:
What the debt is used for.
The terms of said debt.
The rich use debt to buy things that will make them money, the poor use debt to buy things they can’t afford.
Robert Kiosaki very famously publicized the difference between assets and liabilities in his book Rich Dad, Poor Dad. This was information a lot of people (including myself) needed to learn. While most can quickly grasp how this is implemented using the cash they already have—if you want to be rich, buy assets, don’t buy liabilities—they don’t understand how the concept is amplified with the skillful usage of debt.
Not all debt is created equal. Borrowing one hundred thousand dollars to buy a Porsche and fund a three-month vacation is going to leave most on the road to bankruptcy. Bad debt.
However, using that same one hundred thousand dollars to start a business or buy a rental property is a leverage strategy—an investment that costs more than you could afford with cash that will make you money and pay itself off. Good debt.
The obvious but would be… ”But what are the terms?” Borrowing money only makes sense if one is borrowing cheaper money to pay off more expensive money (e.g., taking out a low-interest personal loan to pay off a high-interest credit card), or if one believes the money they can make off the loan exceeds what the loan will cost them.
Continuing with rudimentary examples, if you buy a rental property for a hundred thousand dollars at a 4% interest rate, and you project your net annual return will be 9%, well, that debt will allow you to hold an asset that makes you $5,000 per year while paying for itself.
However, if the interest rate on your one hundred thousand dollar loan is 8%, it’s probably not worth taking on the risk for a 1% return. What is the spread, and does it make the loan worth it?
This logic extends to the ultra-rich, large businesses, and corporation as well. If cheap money is readily available, it can fuel growth and acquisitions. If money is not cheap, borrowing it will bleed an individual or company dry, and thus a different path should be pursued.
As “negative interest rates” become a mainstream talking point, I think we can safely say we live in the era of cheap money. While I morally abhor it, I am fascinated by watching how it is utilized. When debt is cheap and readily available, the spread doesn’t need to be as big. Economies of scale. If an entity or individual can borrow money at close to 1%, even a 4% return becomes highly profitable. This is happening at a mass scale on the international level, where foreign money can be borrowed for close to 0%. When money is mostly free, the yield required to service the debt is next to nothing—it’s all profit no matter how small the margins.
As I’ve watched this happen, and taken an “if you can’t beat them, at least play the game with the same rules,” approach to finance, I am constantly looking for chances to use debt to expand holdings and create yields. Like all operators and investors, I use debt and leverage at a high level, but I’m always looking for ways to implement it on a smaller scale as well.
For example, I’m a big proponent of playing the 0% credit card game. People with good credit receive offers for “0% introductory rates” all the time. Often for between nine and fifteen months. This is a great way to learn to play the cheap money game.
I’ll give you a case study: I open one of these cards with the longest 0% introductory rate I can get. In this case, twelve months. I use the card to make purchases I was already going to make, but instead of using cash, I’m using debt. I pay the absolute minimum each month. Two of the most recent times I have done this, I put fifteen thousand dollars on the card in short order. This could be looked at two ways:
I am fifteen grand in debt.
I am using cheap money while keeping my own.
Both of these are true, but remember, I was already going to spend that fifteen thousand. However, instead of spending cash, I borrowed the money at no cost, while keeping my cash and allowing it to earn a yield. In this case, it was in a savings account earning 2.2%. At the end of the introductory period, I paid the card off in full. But during those 12 months, I earned $330 in interest. With money I technically didn’t have.
Now of course there are dangers to this approach as well. The idea behind 0% Introductory Rates is to get a consumer to see “FREE MONEY” and then spend it. However, if at the end of the twelve months they can’t pay it off, all of a sudden that “free money” just became very costly (revolving credit card interest is usually among the most expensive). Using free money advantageously involves keeping track of how much you are spending, and not spending one dollar more than you have on hand to pay back.
It’s not about using money you don’t have, it’s about using free money temporarily while keeping yours in reserve. And ideally, earning a yield. I enjoy this game a great deal. In addition to 0% interest rate periods, I also utilize the perks offered with new cards. My wife and I paid for one way of our airfare to Europe for our honeymoon because of a miles-matching bonus on an airline card. We did this spending money we would have spent regardless.
More recently I used a business card that had a twelve months 0% introductory period, offered 1.5% cash-back, and had one of those $500 bonuses if you spent a certain amount within the first three months. I timed the opening of the card to coincide with some larger purchases, and thus earned the 1.5% cash back, got the $500 bonus, and kept my own cash on hand and earning for a year while I used this company’s money for free.
While this is low-level, standard consumer economics, it’s a game I enjoy playing as a microcosm of the larger-scale debt economy.
Recently, I tried to play it at a slightly larger tier. I received an offer for a Business Line of Credit with an introductory rate of 4% for the first year. I applied for a hundred thousand dollars. At the same time, I found a relatively low risk, short-term investment that was paying out 7.15%. My plan was to borrow the one hundred thousand dollars and deploy with a delta of 3.15%. While I would by no means get rich, over the course of the year it would yield $3,150—for doing not much more than moving money around. Money that wasn’t even technically mine. That, at a micro level, is how the debt game works. But instead of thousands of dollars, they’re playing with billions. And then that 3.15% delta starts to matter. A lot.
Of course, debt should be approached with great caution. In the above scenario, it’s a great plan unless the investment I put the borrowed money in failed and was lost. Then I would owe one hundred thousand dollars with no way of paying it back. Bad debt and over-leveraging has been the demise of everything from small businesses to multi-billion dollar, publicly-traded companies.
In this case, after going through the loan process, the final terms offered weren’t favorable enough to make this particular opportunity worthwhile. Which is another lesson in itself: Debt is best used when not needed.
Whether I like it or not, the debt economy is here to stay. And while the usage of debt has many pitfalls, it is an extremely powerful tool used by the ultra-wealthy (there’s a reason Mark Zuckerberg has a mortgage) and I am determined to understand it and wield it to my advantage. Even if it’s just for a couple free flights to Europe every now and then.
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Afterword: This is just the tip of the iceberg in regard to the conversation on the debt economy. I had to cut it off because I was already at 2,000 words, but I wanted to share some introductory concepts, and may revisit the conversation in a more nuanced and detailed way in the future. I hope it was helpful.