Friday, July 23

Who owns you?

As promised Wayne delivers a good post on the traps of buying houses as an alternative investment. I would just like to add that one reason it should be considered medium-to-high risk investment is because it is actually two investment that needs to be coordinated. On one side your investing in property as an inflation hedge and on the other your using it to generate income through rental, which can give surprisingly low returns. Although your investment can be considered 'safe' as an asset backs it up, the risk of under performing even a simple money market account is substantial (especially in property price boom times such as these).

Saving is all good and well, but I want to add to this discussion the question of how much debt should you have, or even should you have any debt?

Capitalism as a system works very well. Unfortunately our education system does a particularly bad job of explaining how capitalism can work for you. It might be obvious, but I'll state it anyway: To be a capitalist, you need capitol. Unless you’re one of those lucky people whose forefathers decided to bless or curse you with a substantial trust fund, this is going to mean borrowing money.

Each person has a certain amount of debt that they should have. If you don’t have that debt it is money going to waste. Unfortunately there is no simple formula which can be used to calculate the amount of debt you should have. The bank will only lend you the amount of money that they think you can have.  The amount you should have is determined by your age and personal situation (called your risk profile), ability, get go, and your goals .If your comfortable as a part time cocktail waitress, kudos to you. Few people ever realize money isn’t a goal.

This means that if your young, with ambitions of the good life, and you feel that money at prime is money sitting idle, you should theoretically be up to your eyeballs into debt. You should borrow as much money as humanly possible. Your first call everyday should be to your venture capitol bank manager saying: Can I get more money?

When do you stop borrowing? This ones easy and has been figured out for centuries. In olden times it is when you would be sold of into debt bondage for the rest of your life. These days you declare bankruptcy. What I’m trying to say is there is little middle ground. You are either successful in adding value to the money your borrow, thereby allowing you to service your debt, or your not in which case you should not have borrowed so much money. Oops.

Debt is not a bad thing. Debt is the stuff that makes life possible. You should be an intimate friend of debt, because you'll never get anywhere in our society without her.

That said, not all debt is good. Any debt that you cant service or where no value can be added to the debt is bad debt. Borrowing money for your living expenses is money down the toilet. Buying a car (in most cases) is bad debt as the value of the asset decreases with time.  Sometimes you need bad debt, but bad debt is something completely different from good debt. Good debt should not even be called debt as to totally disassociate it with bad debt. It should properly be called capitol (albeit with strings attached, but isn’t there always?).

There is a safe route through the debt capitol jungle however. It’s called a career. Your income allows leveraging capitol, covering your expenses so as to avoid bad debt and serves as an insurance policy against you losing everything. It might not be as exiting as striking out on your own, going up to your eyeballs into capitol, and praying that the accountant doesn’t mention cash flow and problem in the same sentence, but it works.

You should still make sure that you have the proper amount of capitol at all times. There is nothing so sad as a man who boasts about not owing the bank anything.

What debt should you have? You should owe money on your house. If you don’t, buy a bigger house. Servicing the extra debt is going to cost a lot less than the money you’re going to make on the capitol gains of the house. Alternatively mortgage the house to the max and start a small business. Employ a person at minimum wage to run it. Buy a farm, and have someone else manage it for you. If a friend wants to start a business and it sound reasonable invest in him. Have your house re-evaluated and if the bank will lend you more on the house get that money. Use your capitol, because you can only get so much of it.

A career is a stepping-stone to becoming a capitalist, and in this game the man who owes the most is probably winning.


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