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What is Debt? Why is it Demonized?
If anyone wants to be financially independent as quickly as possible then debt must be known and not scared. Here I’m explaining why. In the global economic system, “money” can actually be defined as “debt” or “credit.” Almost everyone involved in investments understands this, but when it comes to borrowing, most people are afraid. But why? Why is a long-term debt with reasonable interest rates scary?
First and foremost, I believe the biggest reason for this is psychological. Debt creates mental distress in many individuals. Living completely debt-free without taking any risks may seem like the easiest option, rather than living with the fear of not being able to repay. However, the only way to preserve the value of our hard-earned money is through accumulation through borrowing. If you imagine your personal financial situation like a company, you will better understand what I mean.
If you try to save money to become a homeowner, good luck, you will likely waste years. Due to the unlimited money supply, your money will be eroded by inflation, and each passing year will decrease the possibility of buying a house. You might say, “Well, I can invest in stocks, cryptocurrencies, and such.” Of course, you can. However, even in that case, your options for acquiring assets will be limited, and you will have to continue accumulating for many years.
Once you have managed your cash flow well, debt should be one of your important tools. If the country you live in has a currency that is being eroded by inflation, I believe you should take on the largest amount of debt possible in the local currency. You can live with debt until the end of your life, as long as you establish a balanced system.
What is the Best Type of Debt?
The best type of debt is low-interest, fixed-rate loans. For example, a mortgage loan. If you can obtain a long-term loan with an interest rate tied to inflation, you would have made a very profitable deal. For those who cannot obtain a mortgage loan, personal loans can also be reasonable. Although the limits on such loans may not be high, you can benefit from these loans with low-interest rates. It is important to remember that the interest rate should be fixed, not variable, because an increase in central bank interest rates could put you in a difficult situation.
The beauty of a long-term loan lies in making your payments in monthly installments. Over the years, if you have taken out a mortgage loan, the nominal value of your house will increase due to inflation, while your debt will decrease in value despite interest payments. Short-term, volatile movements such as the formation of a housing bubble or price drops will not affect you in the long run.
As seen in the graph, there are periods of decline, but overall, prices seem to always rise. We can observe a decline in prices between 2007 and 2011. However, for someone who took out a 30-year mortgage in 2000, this period of decline may not have a significant impact. Since the repayment of the debt is already a portion of your income, there is no problem. Furthermore, you have the potential to increase your income every year. The most important thing is that you are not obligated to sell your house just because its price has dropped. I will explain the vital importance of this.
The Worst Type of Debt
The worst type of debt, in my opinion, is borrowing for margin trading. Taking on debt for margin trading carries a significant risk, even if you have the capacity to repay the debt. Stocks are subject to dramatic fluctuations in value, experiencing both sharp declines and rises. The collateral for the borrowed funds in margin trading is either your existing stock holdings or cash. If you open a long position and the stock price drops within a certain period, you will receive margin calls and be forced to close your position entirely. In short, you may end up bankrupt. If you had taken this debt in installments over the long or medium term, you would not have to worry about margin calls. You would simply make your monthly installments and continue buying and selling stocks in the spot market based on their prices.
In summary, what I mean is that one should avoid collateralized debts as much as possible. While a mortgage loan may also be considered collateralized, as I mentioned in the previous paragraph, the bank does not demand that you sell your house when its price drops. You continue to make your mortgage payments and carry on with your life.
Dept to Equity Ratio
One important concept that requires careful consideration is the debt-to-equity ratio. Taking on excessive debt can lead to financial ruin. Human beings are often driven by greed, and debt can become addictive, much like drugs. You should never take on debts that you cannot repay. It is always important to have backup plans and contingency measures in place.
Let’s imagine you have a stock portfolio worth $100,000. You have the opportunity to take out a personal loan, with a maximum limit of $10,000 and an annual interest rate of 10%. If you can spread the repayment of this debt over the long term, let’s say 6 years, the approximate monthly repayment would be $185.
If I have income, such as dividends or a salary, I can repay this $185 monthly amount and repay a total of $13,320 over 6 years. The probability of my investments surpassing this amount in the 6-year period is quite high. Let’s consider the worst-case scenario, as I like to discuss worst-case scenarios. Suppose by the end of the 6th year, our $110,000 portfolio has declined to $100,000. This means that throughout the 6 years, you have not made any gains from your investments. Unless there is personal incompetence involved, you may be experiencing one of the most valuable periods in the market, as financial markets tend to rise in the long run. In this case, the appropriate action to take would be to adjust your debt-to-equity ratio and consider borrowing again.
I personally believe that a debt-to-equity ratio of 10-20% is relatively harmless. Especially if you can repay the debt from the cash you generate, there is no need to fear. If you are considering selling stocks to pay off the debt, you should proceed with caution and conduct a thorough analysis.
Is Debt Risky?
Sometimes doing nothing, and staying in our comfort zone, can be our biggest enemy. Risk is inherent in life. When you invest, you can risk losing your money. When you keep it in cash, the probability of loss is close to 100%. Money is an illusion. What matters is purchasing power. I never believe that there are people who can preserve the value of their money by depositing it at an interest rate. A good investor should always have long-term debts. I’m not talking about high-leverage operations. In futures or margin trading, the risk of loss is very high.
My Debt Strategy
The USD is the world’s most important currency. We can say that it is the currency least affected by inflation. Therefore, I am not against investing in Eurobonds. A Eurobond with a good interest rate can provide better returns than many stocks. If you live in a country that is fighting inflation, it makes sense to take long-term loans in that country’s currency, such as Argentina, Turkey, or Lebanon.
At the end of the day, the dollars in your hands will appreciate compared to the local currency, and your debt will, so to speak, turn into waste. We have to keep up with the financial system. That’s why I say taking on debt makes sense. I am fully aware of the extreme income inequality brought about by this system, but if we cannot bring a solution, we must adapt, dear friends.