Getting Rich With Debt — Using Debt to Achieve Financial Freedom (The Value of Debt in Building Wealth)
Conventional thinking tells us that the first step to financial freedom is to avoid debt. This is unfortunate. Because debt is a powerful tool.
These two short sentences simply state the purpose of this entire book, how to use debt to help us achieve financial freedom.
Before reading this book, I was stuck in the traditional mindset that debt is bad and that it’s only right to pay it off early, but I never realized that sometimes debt can be a tool to help us increase our wealth.
It never even occurred to me why many companies with extremely high cash levels would take on debt. It should be very difficult to find a completely debt-free company, even if it is in good shape (e.g., the light of our nation’s enterprises, TSMC), it will have debt.
When you think about it, you will realize that debt is not as bad as conventional thinking.
The author of this book is a well-known financial consultant in the U.S. This is also his third book, the first two books also focus on debt (The Value of Debt and The Value of Debt in Retirement), I feel that this book is not an extension of the first two books, although I have not read the first two books, but I feel that this book is very simple and easy to understand, although the figures in the book (the salary section) are denominated in U.S. dollars, which is something that I am accustomed to. I’m used to converting them to Taiwan dollars, so I often get stuck on the numbers for a while (poor math after all…) and since the basic salary level in the US is higher than in Taiwan (the average annual household income in the US is 60,000 USD, which is almost 1,800,000 TWD), I may think that the amount is too high when converted directly, but on second thought, I don’t think it’s necessarily the case.
Next, I will summarize the key points I learned in this book, and put the summary of the whole book at the end.
1. Breaking away from conventional thinking
In our anti-debt world, I believe that most people start life with too much debt and are too eager to pay it off. For this reason, they don’t start saving until much later in life. I believe that this strategy is too costly for society as a whole and that there should be a better, more balanced approach. -P.41
This book argues that your cash liquidity must also be taken into account when paying off debt, and even more so when prioritizing cash before anything else.
The reason for this idea, from the power of compound interest can not be ignored, when you save for a long time so that the cash level rises, the amount of money that can be saved and invested will be more and more huge, and more with the formation of the power of compound interest over time (I think readers who will click into this article should have a certain understanding of the compound interest, I will not go into it here).
Because compound interest in addition to the principal, the other condition is the accumulation of a long time, to increase the rate of compound interest, you must put more cash in this area, to generate a strong enough compound interest.
Having said that, it seems that compounding has all the advantages and none of the disadvantages, but compounding also has the possibility of falling a lot because of the high risk, and I would like to remind you that compounding is also risky. For example, if the subject of your investment falls drastically, then your assets will shrink drastically, so saving is the most important thing.
The author of the book sets an ideal goal of 15%, but also suggests at least 10%, and has a plan to work for a long time. If you have a short career (like an athlete), you need to save up to 30%. It’s important to enjoy life while saving.
2. The 4 stages of the L.I.F.E. (L.I.F.E.). (Net wealth = total assets — total debt)
1. Launch: Net wealth is less than 50% of annual pre-tax income. You need to reduce your debt (e.g., card debt) and build up a savings reserve.
2. Independence: Net wealth is 50% to twice your annual pre-tax income. Start thinking about buying a house or utilizing functional debt.
3. Freedom: Net wealth is 2 to 5 times annual pre-tax income. Use the debt strategies discussed in this book to gain financial advantage.
4. Equilibrium: Net wealth is more than 5 times annual pre-tax income. You are ready to retire and enjoy your life at the same time.
The author suggests that if your net wealth is 50% to 2 times your annual pre-tax income, you can start thinking about buying a house or utilizing your functional debt. But I don’t agree with the idea that if you make $50,000 a year as a woman with a small income, you only have $25,000 to $1,00,000 in net wealth, which is not enough for a down payment on a house, so you should at least have a net wealth of 2 to 5 times your annual pre-tax income before you consider buying a house.
However, after thinking about it, I can understand why the author doesn’t think you need so much money. One reason is that the book is set in the United States, where housing prices are not as high as they are in Taiwan, and the other is that the author believes that when you have a stable cash flow, backed up by a certain amount of net worth, you don’t have to worry too much about your cash flow being cut off, but of course, this is all based on the premise that you have a healthy financial health.
Back to the topic, readers can evaluate their own in which of the four stages, and choose the book’s corresponding goals, and strategies for their financial management, the following is a little briefly shared, and more detailed please go read this book.
a. Start-up stage: You should do everything you can to avoid incurring any new debt. There is more than just crushing debt (e.g. credit card debt, debt with interest rates higher than 10%, etc.), and building a cash reserve equal to one month’s income, introducing retirement savings, such as a U.S. 401(k), and growing the cash reserve (the goal is 2 months).
b. Independence Stage: There are two types of stages:
(a) not to consider buying a house: no crushing debt as a prerequisite, you should keep 3 months’ worth of emergency funds in your account, build up your retirement savings (target 6 months), and build up a large life-changing fund (e.g., get married, buy a house, etc.).
(b) Consider buying a house: Evaluate your financial situation to see where you fall on the list above.
c. Freedom Stage: This is the period between 10 and 15 years of your life. At this time, in addition to the above, long-term investments and others (including personal real estate, such as cars, wedding rings, and home furnishings) are added. As mentioned in this paragraph, if you buy a house, do not pay off the mortgage principal too early.
d. Equilibrium Stage: In this stage, debt does not add value, so there is no need to take on additional debt risk.
3. Evaluation of Renting and Buying a Home
The book reiterates that unless your net wealth exceeds 50% of your annual income, you are strongly discouraged from buying a home or acquiring any major assets.
Simply put, don’t buy a house if you’re still starting.
Our society encourages people to buy homes too early because we believe that homeownership contributes to financial freedom.
I would suggest that unless you and your family are free of any crushing debt and have savings equal to at least 50% of your annual income, the risk of buying a home is too high and should not normally be considered an option.
The reason people rush to buy a home is usually because they believe that renting is a waste of rent. The problem with this view is twofold:
1. Many of these same people are insured, but when it comes to accident protection, the most important thing is cash in the bank. At this stage of starting, there is not enough liquidity to afford the risks involved in buying a home, and renting is another form of insurance.
2. Assume that the arithmetic of renting versus buying is clearly in favor of buying. However owning a home involves interest, taxes, repairs, and depreciation. Considering all the costs of buying a home and comparing it to renting, one might be willing to choose the less costly option of renting.
Regarding when to buy a house, Mr. Chueh Maikan has not only mentioned the concept in his book but also on Facebook that the first bucket of money should not be used to buy a house. In this case, the first bucket of money is 3 million dollars, which is the amount of money that can be used as a down payment. The idea is similar to some of the ideas in this book, which is that it’s much better to have a pot of money that can help you create compound interest than to put it into real estate right off the bat.
4. Don’t pay off your mortgage
This is the most important point in the book!
I was shocked when I saw this theory, but I intentionally put it in the last point to share, is to combine the previous three points, when you originally want to pay the mortgage part of the cash to save and invest, you can accelerate the water level of your cash and savings account, and then increase the compounding effect of interest.
The Debt Pathways table in the supplement:
Finally, this is the paragraph that struck a chord with me as soon as I picked up the book, and I’m sending it to you who are reading this.
I would recommend that you live in the smallest house you can afford, not the biggest house you can afford. I would tell you that it may be wiser to rent than to buy, especially if you are just starting to make money. I’d ask you not to buy the latest BMW, and I’d ask you to think long and hard before you take a plane to Tulum, Mexico for your vacation. I would ask you to buy less and spend less than you can afford. -P.21
I hope that all readers can successfully find their blind spots in financial management from this book, or can re-examine their own financial planning for problems, and together we can move towards the road to financial freedom!
Book highlights:
Crushing Debt:
- Remove it as soon as possible.
- Break the moonshiner’s demons.
- Make sure you’re not running a retirement plan to save hard while paying high credit card debt.
- Build liquidity. Keep sufficient emergency funds in your accounts.
Own a home:
- Many people buy homes too early.
- Buying a home is not worth it if it leads to a lack of liquidity.
- Renting a home is not about wasting money. It’s about risk management and flexibility, using other people’s money to build your own wealth.
- Renting a home can provide significant value unless you are completely debt-free, have a net wealth of at least 50% of your annual income, or even close to twice your annual income, and you know that you will live in the home for at least 5 years.
Borrowing:
- Borrowing costs should be as close to inflation as possible, preferably no more than +2%. If you can get a 4% return on your investment, you can earn a spread.
- Avoid 15-year mortgages unless your cash flow can match and your savings rate is at least 15%.
- An interest-only mortgage is a good idea, but only if the aforementioned criteria are applied.
- A 30-year mortgage may be a step in the wrong direction, but usually only if you’re planning to live there for at least seven years.
Get a handle on spreads:
- Even a small spread of 2% can add up over a lifetime.
- Spreads of up to 4% can mean the difference between being able to retire and being able to afford it.
- Spreads of up to 6%, compounded over a lifetime, can be quite impressive, but may not be worth the risk.
- With proper asset allocation, I think it’s quite possible to invest in rents and master spreads over a 10, 20, 30, or 50-year period.
Risk:
- It is better to quote larger assets to earn a stable and relatively small spread. This is a marathon, not a sprint.
- Over the long term, risk is as important as reward.
- It’s not worth taking major risks in the early stages of life, but you can’t afford to take risks in the later stages.
