The Real Story Behind Debt: If Cash is King, Then, what is Debt?
The Skewed Narrative of Debt
In today’s financial landscape, the narrative around debt often feels skewed. Many people, particularly those who are less financially literate, are constantly warned about its dangers. They’re told to pay off their loans as quickly as possible, to live within their means, and to chase the elusive goal of being completely debt-free. Meanwhile, the wealthy have a different relationship with debt. They leverage it to build their empires and expand their wealth. So, what’s really going on here?
My Personal Journey
Challenges Faced
This scenario reminds me of an experience I had as a high school student. I vividly recall my guidance counselor telling me that I didn’t need to take geometry or algebra since I wasn’t going to college anyway. Instead, I could opt for vocational classes, which would be much easier. Now why would she say that? Why would she rear me in that direction? I was only fifteen, why would she pigeonhole me? I have an idea or two about this topic…left for another day, another blog:) Perhaps it was because I was a first-generation immigrant in the U.S.. Regardless, I felt judged, labeled, and directed down a path not of my choosing. Somehow, I took the college prep classes, went to college, and graduated.
Now, when I see bloggers and Tik Tokers talking about personal finance, I can’t help but feel they’re doing what my guidance counselor did: steering people in the wrong direction. They stand on their pedestals, promoting the idea of being debt-free as a badge of honor. But why close doors for someone when you can open them? Instead of demonizing debt, we should be teaching people how to use it wisely.
Financial literacy should involve comparing the potential of cash versus debt, assessing risks and rewards, and helping individuals understand how to create an optimal strategy for leveraging debt.
Lessons Learned
Going to college was the American Dream for me, just as debt can be the American Dream for so many others seeking financial freedom. Isn’t the "American Dream" a cultural ideal suggesting that anyone, regardless of their background, can achieve success and upward mobility through hard work, determination, and initiative?
Then to truly embrace this dream, we need to analyze the pros and cons of debt, enabling everyone to make informed choices rather than succumbing to fear.
Source: (OECD, 2022, “Household Debt, % of net disposable income" 2022: OECD, OECD Publishing, Paris).
Let’s look at some statistics around the world:
According to OECD data, the U.S. ranks 8th in household debt as a percentage of GDP. (See Charts and Table from the IMF and the OECD.) However, I'd like to highlight another significant trend in the data: developed countries tend to carry higher levels of household debt compared to developing nations. In fact, many people in developing countries would jump at the opportunity to access debt at the interest rates available to us in the U.S. and other developed nations. Debt is not as readily accessible in many developing countries. We are fortunate to have an efficient legal and financial system, which allows us to access relatively inexpensive debt. In fact, I would argue that the U.S. is among the leading countries when it comes to this access. This advantage can be largely attributed to our robust legal framework and the lower frictions present in our financial markets.
The Scare Tactics Surrounding Debt
It’s no surprise that people who are not financial savvy often hear debt described as a burden. This fear is perpetuated by well-meaning advice that suggests living a debt-free life is the ultimate goal. While being free from high-interest credit card debt is undoubtedly important, the narrative can become dangerously misleading.
The underlying message often goes: “If you’re in debt, you’re failing.” This creates a stigma that prevents individuals from viewing debt as a potential tool for growth. The truth is, many wealthy individuals leverage debt strategically to maximize their investments and create opportunities.
How the Wealthy Use Debt to Their Advantage
The rich have learned to conquer debt, viewing it as a means to an end rather than a burden. They utilize “other people’s money”—whether that’s loans from banks or funds from investors—to finance their ventures. This approach allows them to invest in assets that appreciate over time, such as real estate, businesses, or stock market investments.
Consider this: when the wealthy borrow money at a low-interest rate, they can use that capital to generate returns far exceeding the cost of borrowing. For example, if they take out a loan at 4% and invest that money in an asset that returns 10%, they’re essentially profiting from the difference.
The Inflation Factor
Inflation plays a crucial role in this dynamic. As the cost of living increases, the real value of debt diminishes. When you borrow money, the amount you repay may not hold the same value years down the line due to inflation. In other words, if you’re paying back a loan with a fixed interest rate, the effective cost of that loan decreases over time.
Let’s say you have a $100,000 loan at 4% interest. If inflation is at 3%, the real interest rate you’re paying is only 1%. This means that, in the grand scheme of things, the debt you’re servicing isn’t as burdensome as it appears. The money you’re paying back is worth less than when you initially borrowed it.
Changing the Narrative
It’s time to shift the conversation about debt, particularly for those who are struggling financially. Instead of viewing it as a demon to be exorcised, consider it as a tool that can be wielded wisely. Debt can enable investment in opportunities that lead to wealth creation.
The goal shouldn’t necessarily be to eliminate all debt but to manage it effectively. This means understanding the terms of your loans, recognizing when debt can be advantageous, and using it to invest in assets that appreciate over time.
Final Thoughts
In a world where financial literacy is more crucial than ever, it’s important to debunk the myths surrounding debt. Wealthy individuals have mastered the art of leveraging debt to build their fortunes, while many individuals who are less savy with personal finance are lead to fear it. By changing our perception and approach to debt, we can unlock new pathways to financial growth and security. Embrace the idea that debt, when managed properly, can be a stepping stone to wealth rather than an obstacle to overcome.
Let's start viewing debt as a tool for opportunity, not just a source of fearmongering of the unknown. After all, it’s not about being debt-free; it’s about being financially savvy.
So, if Cash is King then Debt is the Empress!
Frequently Asked Questions:
Q: Isn’t all debt bad and something to avoid at all costs?
A: Not necessarily. While excessive or mismanaged debt can be harmful, not all debt is bad. Responsible debt, like a mortgage or a student loan, can be an investment in your future, allowing you to acquire valuable assets or increase your earning potential.Q: How can debt be beneficial to my financial health?
A: When used wisely, debt can help you build credit, buy a home, fund education, or even start a business. It can also enable you to make investments that may increase in value over time, which can contribute to long-term financial stability.Q: Doesn’t carrying debt mean I’m living beyond my means?
A: Not always. Debt can help manage cash flow or cover large expenses over time. If you have a plan to pay it back and can comfortably make payments within your budget, it doesn’t mean you’re overextending yourself.Q: Isn’t credit card debt always a bad idea?
A: High-interest credit card debt can indeed be risky, but using credit cards responsibly—paying off the balance in full each month and not carrying a balance—can help you build credit and earn rewards without incurring unnecessary costs.Q: Why would anyone choose to take on debt instead of saving up first?
A: Debt allows you to make significant purchases sooner, like a home or education, rather than waiting until you have the full amount saved. This can be particularly useful when the investment is expected to grow in value or improve your income potential over time.Q: Isn’t debt risky because it can spiral out of control?
A: Debt can indeed become unmanageable if not monitored closely. However, with responsible use—such as borrowing within your means, having a repayment plan, and keeping track of interest rates—debt can be managed effectively without becoming a burden.Q: Doesn’t debt hurt your credit score?
A: Debt alone doesn’t hurt your credit score. In fact, responsibly managed debt, like making on-time payments and keeping credit utilization low, can improve your score. It’s the failure to manage debt well that negatively impacts credit scores.Q: Isn’t paying interest just throwing money away?
A: Paying interest can feel like a loss, but it’s the cost of having access to funds you don’t currently have. If the debt allows you to make a valuable investment or achieve a long-term goal, the interest can be worth the benefit gained.Q: Wouldn’t it be better to be completely debt-free?
A: Being debt-free can be a great goal, but not all debt is inherently harmful. For example, mortgage debt can provide the benefit of homeownership, which may appreciate in value. Some types of debt can be advantageous when they’re managed well.Q: How do I know if I’m using debt responsibly?
A: Responsible debt use involves borrowing within your means, understanding the terms of your debt, and having a repayment plan. If your debt payments are a manageable part of your budget, and you’re not taking on new debt to pay old debt, you’re likely managing it responsibly.
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