Want To Get Rich? Get Into Debt!

I’m sure everyone has heard the old financial saying “Save your money, don’t get into debt.” Sounds like good financial planning doesn’t it? After all, how can one get rich if they’re up to their eyeballs in debt? Well I’m here to tell you that advice is the worst piece of financial advice ever given. To get rich you must be heavily in debt. The key is to have the right kind of debt. What is the right kind of debt? Debt where the interest is tax deductible. Any debt other than that is bad and you should avoid them. The problem is most people have bad debts, and lots of it. Let me show you the power of good debt.

We’ll begin with example A. Say you have $50,000 to invest and decided to dump it all into a mutual fund because your financial planner told you that funds are “great investments”. I have a lot to say about mutual funds but that’s for another blog post. If the value of the fund goes up by 12% in a year you made $6,000. Not too bad. You’re making money, but are you getting rich?

Let’s try example B. You take the $50,000 like before but this time you top up the investment with another $300,000 drawn from your home equity line of credit for a total investment of $350,000. Assuming the same 12% return, you would make $42,000 from this investment. Interest on the line of credit is at Prime (currently 5%) so you would pay $15,000 of interest for the year, which is tax deductible. Your original investment was $50,000 and you got back $42,000 for an 84% return on investment, verves the 12% when no debt was used.

This is the power of using debt to get rich. Of course in real life you would use borrow money to buy other investments and avoid mutual funds like the pledge because they’re the biggest scam filled no good pieces of….. Ugh, that’s for another day.


17 thoughts on “Want To Get Rich? Get Into Debt!”

  1. Carl says:

    So you spend the first 7-8 years paying back the loan with the earned interest?

  2. John Chow says:

    No you don’t pay off the loan. You just pay off the interest, which is tax deductible. You are allow to pay interest only on a line of credit. When you sell the investment, you repay the line of credit. As long as the investment makes more than the interest cost on the line of credit, you’re ahead of the game.

  3. Christoph says:

    Using borrowed money for investments like this is very bad financial advice. First of all – even if the interest is tax deductible it is still interest that you pay. Then – the risk that the financial investment heads the opposite direction is very real and can put your house at risk to be sold by the bank because the debt now exceeds your equity. Go back in time 6 years. So many people did exactly what you describe here and the bubble burst and loans could not be covered and paid off anymore. They went broke and lost everything with the Internet bubble “blowing up” Nasdaq and NYSE.

    I am not saying borrowed money should not be used to cover investments, but it is by far not that black and white as described by you.

    Christoph

  4. John Chow says:

    Very good point Christoph, it’s never black and white. The point I was trying to make with this post was to say that the rich never got there using their own money. Almost every one of them used some level of leverage.

    Of course there are risks, but if done correctly, the risk can be managed.

  5. Sharon says:

    I never would have understood this fully until we did the Cashflow 101 Game. Interesting. I had to explain to Montana.

  6. Stephen says:

    This is called trading on margin, and it’s very high risk.

    There are other ways to get rich. A sound investment strategy should be patient and take the long view, and above all, it should seek to protect the principal first.

    What John doesn’t explain is what happens when your investment depreciates by 12%. Now you have a $42,000 loss, and your principal is almost totally wiped out.

    This is how commodities traders and high rollers do it, and MANY more people have been wiped out than have made it big. It’s legalized gambling. This is not investment advice, it’s an instruction for speculation.

  7. John Chow says:

    Stephen – So I guess all people borrowing 90% to buy a house are all speculating? 🙂

  8. One man’s investment is another man’s gamble.

    In other words just because you think it is gambling doesn’t mean it is for everyone else. Lotteries are legalized gambling, any other sort of investment is only gambling if you do not know what you are doing.

    Sure, some big rollers have been wiped out, but you know what? They know how to make money and therefore being wiped out isn’t as bad for them because they can get it back.

    John is right, the only way to get money more quickly than saving it is to leverage someone elses money. He is also right on with the points of buying a house. Unless you are paying cash, then you are leveraging someone elses money.

  9. Stephen says:

    John: Some of those borrowing 90% to buy a house are indeed speculating (just look at all the frantic investors in the US with ARMs who are now looking down the barrel of a gun as the interest rates creep up).

    What’s more, that’s not a purchase on margin — you’re only risking the accumulated equity in the invested asset. What you’re proposing is taking secure equity from one investment and risking it on a much more volatile and risky second investment. You’re multiplying your reward, but also your risk by an equal amount.

    One thing I would never counsel anybody to do is use equity in a principal residence to finance an investment in a tradable security.

    Have a look at Benjamin Graham’s book, “The Intelligent Investor”. Whether you are investing for growth or more conservatively, your first priority should still be protecting your principal.

    Warren Buffett got rich following the same approach 🙂

  10. If you’re investing for the long term and buying stable dividend paying investments (Canadian) there is limited risk in using your home equity line of credit to invest. Not only do you get the tax break from your interest payments, you get the tax break from being invested in Canadian dividends.

    Just some food for thought.

    StingyFinance

  11. Kenric says:

    John,

    It’s very difficult to convince people about the power of leverage and debt. I’ve found that it’s almost like arguing religions with other people. You will never convince them that certain debt is good.

  12. prlinkbiz says:

    John- Ken is probably referring to, among other things, this discussion over at the Investor Geeks:
    http://www.investorgeeks.com/articles/2006/11/16/lets-change-our-goals-around/
    and then this one as well:
    http://www.investorgeeks.com/articles/2006/11/22/some-thoughts-on-steves-article-and-personal-finance/

    Personal finanace bloggers, like people tend to be either scarcity or abundance minded. The mindset is everything. “Whether you think you can or can’t, either way your’re right.”

    For the record, I am of the abundance camp (Camp Abundance), and am glad to see your post about leverage used properly!

  13. Richman says:

    John,

    As a Certified Financial Planner I agree with this concept and use it with clients in many applications. The trick is to understand that the concept is risky enough and you don’t need to go overboard with the investment risk as well. Build a portfolio that will generate 8 – 10% over time and this is a great retirment savings vehicle.

    I too attend Camp Abundance

  14. Brad says:

    What about using a line of credit to purchase the new manual life Income Plus.

    You are guaranteed to not lose your principle, you can lock in your gains every 3 years, and you get bonus payments if you dont withdraw any income for a time. Lets say 10 years. It is tax free growth and insured in case of death. From what I know so far you can deduct the interest as interest costs on an investment.

    I understand the gains will not be as much, but you will never lose your house or your marriage.

  15. kim says:

    i just a student , university student . but i ma very very poor , i hope i can get rich , i try to buy bond , but in the end fail . even bond also cannot give me good investment , so i guess , if anyone like me here dont know how to manage money , then we better save money in the saving account . safe for your whole life , rich or not is not reallyu important , at least you are safe and can live a better life without worrying you will went broke.
    right ?
    we cannot playing this kind of gambling games all the times . need to be stable .

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