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As I was sitting in the coffee shop this morning, a thought popped into my head. “How was I able to establish a six-figure net worth before the age of 30?” Because the honest truth is the majority of my wealth didn’t come from saving money. So, If you were to ask me how much of my net worth is in cash today, you’d be a tad disappointed. Instead, the majority of my net worth is tied up in assets. Furthermore, I’ve noticed I used debt to create most of my wealth.
That said, I will kick this post off by dropping a gem.
The majority of millionaires have used debt in some capacity to build their wealth.
You will rarely see any individual with millionaire status flaunting wads of money in pictures and videos other than a Hip-Hop artist. Conversely, most millionaires don’t maintain the bulk of their wealth in cash. Cash alone does not generate wealth. Wealthy money primarily sits in investments or assets that can accumulate more wealth. It may also be a shock that wealthy individuals tend to take on debt even if they could purchase assets with only cash!
Debt is an integral part of life. It helps us buy things we need so that we can pay our bills and save money for the future. But too much bad debt can cause problems. In this post, we’ll explain how to use debt wisely so you can build wealth.
- Benefits Of Using Debt
- Financing a Purchase Can Help Purchase More Assets
- Know When To Pay Off Debt
Before we dive into this post, let’s look at the relationship between net worth and wealth.
What is Net Worth?
Your Net worth (or equity) is defined by the formula below.
Net Worth = Assets – Liabilities
Assets are Cash, Stocks, Bonds, Cars, Real Estate, Jewelry, and other things that have resale value.
Liabilities (or debts) are student loans, car loans, mortgages, credit cards, or anything else you will need to repay in the future.
Net Worth is the equity in your assets. For example, if you have a $200k home and a mortgage of $80k outstanding, you have equity of $120k in that asset. That is $120k that is contributed to your total net worth!
Understand The Benefits Of Using Debt
There are two main reasons people take out loans. The first is to finance purchases of Assets. The second is to borrow against assets. If you consider taking out a loan, that’s not a problem. However, before you go into debt, ensure you understand what you’re getting yourself into.
College is expensive now of days! According to U.S. News, the average college debt for a new graduate is $30,000. But, the great thing about the world today is there are many low-cost and free options to pursue education.
I would argue the internet and Youtube university have taught me more about Finance than my college degree. However, this approach to education may work for some professions, such as Dog training or Information Technology. On the other hand, I wouldn’t want my Doctor or Lawyer to have attained the bulk of their knowledge from Reddit threads and Youtube videos. Could you imagine!?!?
Taking out a student loan to pursue a college degree is perfectly fine. But, If the degree wouldn’t lead you to medical school, law school, or directly into the profession, there are a few things to consider:
- Is the major I’m pursuing worth the debt? Is the job in demand? -Surely, we have to repay the loan.
- How much am I expecting to earn? Will I make enough to pay it back? – No one wants to be in debt forever!
- Is the school I plan to attend reputable enough to get me in the door? – This prevents you from simply having an expensive piece of paper (your college degree).
The main idea is that all debt you decide to take on must be assessed. If the debt can create wealth (more money for you later down the line), it may be worth considering.
Financing a Purchase Can Help Purchase More Assets
I have no clue why I’ve heard from so many people that they only buy things with cash. It doesn’t make sense to me, but I understand that some of us lack the restraint to use credit appropriately. For those individuals, I highly recommend educating yourself and finding a way to incorporate credit into your life responsibly.
Building wealth is hard when you don’t have the cash to stretch! By stretch, I mean use the money to purchase even more assets. So let’s create another example.
Say we have $35,000 in cash.
We want to make two purchases the first is a used car in mint condition (because why buy new?) for $25,000, and the second is a home with a downpayment of $18,000.
You have the cash to buy the car outright with no debt, but should you? The alternative is to take a low-interest car loan with a $5,000 down payment.
If I were in this scenario, I would undoubtedly finance the car so that I could still have the ability to purchase the home as well. However, I wouldn’t want to forgo purchasing a home (an asset that generally appreciates over time) only to buy a car that depreciates over time.
By purchasing the house, you are using debt to create wealth. As time passes, the home’s value goes up (an asset), and you are paying down the loan (a liability), increasing your net worth. This is how debt should be used!
Know When To Pay Off Debt
It’s common knowledge that paying off credit card debt is one of the best ways to improve your financial situation. Credit cards are notorious for having extremely high-interest rates. The best way to use them is to pay them off monthly, so you don’t have to pay interest on the principal. This is a win-win you earn cashback or points that can use to fund your annual vacation. All while not paying any interest!!
If you have found yourself in a pickle of accruing a large amount of credit card debt, establish a plan to pay it off asap. The compounding interest on credit card debt is a wealth killer. The interest will cause the liability to grow exponentially and decrease your net worth.
So, paying down credit card debt is a way to create wealth!
If you have a reasonable rate, low-interest loans, such as student loans, mortgages, and even car loans, shouldn’t have the same urgency to be paid off. Instead, you can use the extra money to invest in more assets, creating more wealth for you!
In Conclusion
Not all debt is bad debt! Use debt to your advantage and make someone else’s money work for you.
You can create wealth with debt!
I know that this is contrary to what plenty of us have been told our entire life about debt being bad. But I’m here to tell you that this is essential to building generational wealth!
Never thought of debt as a good thing, but it all makes sense. Gotta use it to your advantage!