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Thursday, 24 November 2011

Good and Bad Debts - My practical application

Do scroll down and look at my previous post Good debts versus Bad debts - especially the comments page if you have not read it previously. You would get the context and perspective for this post.

We can basically group the opinions into 3 main schools of though:

1) It depends

2) Debt is bad

3) Debt is good


It depends

Most of us will belong to this group. We will say if we buy this, debt is good. And if we buy that, debt is bad... 

Conventional wisdom is that it's "good" debt if we take up a student loan for our MBA . Didn't they say the return on investment for education is the best!?

Tell that to graduating MBA students in a recession... You start with a financial minus the moment you step out of school.  And with no job, how are you going to pay the rent? Never mind about paying down the student loan...

Conventional wisdom will also say it's folly to take up a car loan since the moment you drive the  new car out of the showroom, it's value drops significantly. Your car loan will be worth more than your car's resale value!?

Tell that to those wise car buyers who bravely took out a car loan and bought when COE prices were at their lows during early 2009. Fast forward to today. And we wonder why we like to buy high; sell low for our stocks!? 

(Readers here may want to relook at my previous post's comment page and figure out why I agree with Coconut that during bad times, debt is good!?)

How to classify a debt is good or bad based on the item purchased? You tell me ;)


Debt is bad

For those who believe all debts are bad, I won't ask you how you bought your first home or car. I just ask whether you carry a credit card?

If you truely walk your own talk, you would only carry a debit card - not a credit card.

Otherwise, I will treat you as belonging to the "It depends" school. I don't listen to what you say; I listen to what you do.


Debt is good

During my jouney towards my own financial freedom path, I studied those poeple whose networth were much bigger than me and financially free themselves.

One interesting fact is that all of them have used credit/debt/leverage or other people's money (OPM) during their journey!?

Coincidence?

I also noticed that street-smart and savvy businessmen will secure credit lines with banks when their business are doing well and cash flow positive!?  That's how you can secure the best rates and credit limit - when you don't need loans from banks! Try getting a loan on favourable credit terms when your business is going through tough times...

Similarly, private banks are jumping over themselves to offer favourable credit facilities to high net worth individuals - at interest rates mere mortal like me can't get.  (Who said life is fair?)

And proactive investors with private properties, they already have got their home equity loans pre-approved by their banks - just waiting for the stock or property markets to crash - whichever comes first.

It's good to know that you have access to ready funds when opportunity present itself. Not see the opportunity, then apply for loans (and hope it will be approved) or run here run there asking family members and friends for loans.... It's better than cry daddy cry mommy when others have pipped you to the opportunity; and complain no one believed in your "investment idea"...


Luck is preparation meeting opportunity.


Me? I belong to the Debt is good school.

Since I am the HDB heartlander class of speculator, I have more limited ways to secure credit. I only have the margin account, CFD, and futures route. Big fish got big fish methods; small fish got small fish methods.

When I moved into 50% cash and the balance of my equities are showing healthy paper gains, I applied to my broker to increase my margin limit :)

Hello!? Try asking your broker to raise your margin limit when your account is showing lots of red and very much under water! Why give your friendly broker a heart attack?


Summary

There's no right or wrong answer. Just be honest with yourself. Walk your own talk.

16 comments:

  1. I still like Robert Kiyosaki's definition.
    Good debt is something that will comes with an asset that will give you money and positive cash flow.
    Bad debt is something that will take money away from you.

    ReplyDelete
  2. Hello financialray,

    I do like the way Robert Kiyosaki helped changed the mindset of most property investors by using his cashflow example.

    But I would not push the pendulum to the extreme end.

    In the Singapore context, most property investors make their money via capital gains - not via via rental cash flows. If I invest in Singapore properties, I would go for the capital gains route ;)

    Rich Dad and Poor Dad is one of my favourite personal finance book.

    My main take away is that it would be best if I can be a Business Owner. If cannot, being an investor is the next best thing - at least we still can leverage on OPM and OPT.

    As for negative cash flows, that's how most start-ups and big companys who invest in R&D operate. Cash burn, cash burn - but 1 project succeed will more than make up for all the previous loses combined :)

    ReplyDelete
  3. Yes I agree. From an investors' point of view, I cannot afford to wait for that one project to turn the tide around. I would have drowned in the financial tsunami much earlier before the one money spinner that comes along and change my life around.

    Positive cash flow however is important but it would be nice to have my cake and eat it with a cherry on top when capital appreciation comes along. Similarly, we want dividends in our stocks and of course, we want to buy low and sell high too.

    ReplyDelete
  4. Hi smol,

    Good post, as usual : I'd like to give my views on good debt vs bad debt. I really agree to the fact that when you do not need the money, you'll find it easiest to borrow. Banks are smart, they only want to lend to people who can pay back.

    My definition of good debts are debts that you can pay it back sometime in the future, either using cashflow every month or one lump sum. Everything else is subjective. Some would say that good debt is when you buy a house and bad debt is when you buy a car, but really? You really have to start worrying when the debts that you get is far too high for you to repay back.

    Does the intention in which you borrow the money for matters? If you have money to pay the car in full but you choose to borrow because you want to stay liquid to take adv of market conditions necessary bad? If you borrow money (at low cost now) to get a property to make passive income necessary a good debt?

    I would like to follow how a bank lends to pple, in order to define good debts. A bank only wants to lend to pple who don't need the loan now. That, to them as a lender, is a good asset and therefore a good debt to you, as a borrower. If you can afford to pay back the loans, it'll be a good debt.

    ReplyDelete
  5. That's cool LP!

    Looking at Good debt Bad debt from the bank's (or lender's) perspective!!!

    Now it puts a new spin to things :)

    ReplyDelete
  6. I am with you financial ray!

    We both love our cakes and cherries!

    Dividends and rental income are sweeteners to reward me while I patiently wait for the big capital gains :)

    I'm a growth and income guy!

    ReplyDelete
  7. Now to make things more complicated.

    When you sign up for an MBA and pay lots for sch fees, it is bad debt till you use the MBA upon graduation to earn a high salary, there upon your bad debt has become good debt.

    When you buy a property to make rental income and has positive cash flow, that is good debt. However, when you cannot find a tenant and there is no rental income for a period of time, the good debt has soured and become a bad debt.

    So when we sign up for a course or degree, we must make sure the returns justify the means.

    Similarly before we buy a property for investment, we assess all the risks involved and cover all the "backsides". On leverage, a poor property investment will be a terrible setback but if done well, financial freedom awaits. So location must be good so as to secure a long term anchor tenant for many years to come.

    Just like stocks. It is good investment when it gives good dividends and prices keep going up. For property investment, we just ensure positive cash flow and let time bring about capital appreciation. They don't make land anymore in Singapore, heard shortage of sand and limits to reclaimation.

    So good debt and bad debt, theory liao liao. What is important is we reached our financial goal/freedom.

    ReplyDelete
  8. We may be very financially savvy and know how to generate good returns on our debts.

    But, we may drop dead suddenly, have we seriously think over whoever take over our debts are financially savvy enough to move on with our debts?

    If the answer is No, still a good debt?

    Go up to Bukit Timah Hill this weekend and think over it.

    It is better for us to suddenly leave the mortal world as debt free. No meh?

    ReplyDelete
  9. Hi uncle 8888,

    very good thought.
    this "backside" must be covered for sure.
    good thing about property investment is that we can buy mortage insurance which is a form of term insurance.
    For 1 to 2 k a year, one can be covered for up to a million dollars for death or total permanent disability.
    So if nothing happens over a 20 to 30 year loan, the investor will have the loan repaid and the property to his name.
    If he drops dead or has TPD, he gets a property FOC for his next of kin.

    If can leave this world with family well taken care of, it is good karma.

    Hope that answers your question. No need to go Bukit Timah Hill.

    ReplyDelete
  10. Hello financialray,

    There you go! Without the benefit of hindsight, we won't know whether an action is good or bad.

    So it's back to do or do not, there is no try.

    Who knew a little muppet can have such wisom? LOL!

    Oh sorry! I apologise to science fi fans. Yoda is not a muppet (sound a lot like Grover in Saseme street to me), he is the Jedi master!

    ReplyDelete
  11. CW8888,

    That's why the rules of bankruptcy is one of the best invention of capitalism!

    Without it, there will be less risk taking and entrepreneurship ;)

    And of course insurance...

    Like the automatic hosing loan insurance when you take out a housing loan.

    Be careful if marry a gold-digger who encourages you to buy a big house or multiple properties that you can barely afford. When you "gone"; she get everything for "free".

    Ah! The magic of insurance! You win when you lose; and you lose when you win ;)

    ReplyDelete
  12. I like that quote.

    "Do or do not. There is no try."

    For property investment, it rings so true. They say property investment is perhaps the single most expensive investment of our life time.

    It can help us plan for our children's future education.

    It can help us retire if done right.

    It can help our family if we have mortgage insurance, which is better than buying more life insurance or ILP.

    It can be a form of annuity as we age and not working.

    Unlike the stock market, we can modify the risk profile and control the level of risk.

    Lest I am mistaken for a property agent but now is not the time to invest in property, I feel. Catch the right timing and we can ascend like the wind. Catch the wrong timing and we can end up facing the full wrath of financial hurricane, even if we want to buy and hold.

    Then other factors come in. So location, planning, risk minimisation, plan B, plan C, emergency funds, cash holdings, etc should all be worked out.

    Do or do not....there is no try in our lifetime.

    ReplyDelete
  13. debt is debt, there is no such thing as good debt. leverage is also a form of debt. If banks tell you all debt is bad, then who will borrow from banks.It is good to meansure the risk against the reward before getting a debt.

    ReplyDelete
  14. Welcome Tong!

    It's nice to see a new friend to this blog :)

    Ah! A practical comrade close to my heart.

    No debt = no lending.

    No lending = no banks.

    No banks = either we emigrate overseas; or we ask our "brother" to take us back into the Federation on their terms... We lose our sovereignty :(

    ReplyDelete
  15. Opps! I must apologize to Tong!

    First time come here, and I go off tangent again...

    Sorry Tong!

    You must be thinking... I just woke up, teeth haven't brush, face not washed yet. I only said hello... I have nothing to do with Federation talk! LOL!

    ReplyDelete
  16. wealth888888 made a good point. drop dead!

    having debt is saying you have the ability to pay (with interest) in the future. do you? someone say buy insurance on your bad debt? so can get more debt and more insurance? haha.

    my answer is no one has, not even warrent baffet (if he has debt). i make my life easier and simpler. why so complicated? after tasting it, cherry so nice mah? but for those who have not teast it, including the margin traders, you have to try it and find out yourself.

    note, the effect of the poison always comes much later.

    ReplyDelete

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