Good Debt vs. Bad Debt

One of the most interesting insights I gather through my role helping people with the right financial structure is their attitude towards debt. I’ve seen it all; those that live (sometimes briefly) amazingly, spectacularly fun lives fuelled by credit cards and debt released from their family home, to those that fear debt and are stressed by a penny pinching existence, to everything in between. Understanding how to use debt correctly can turn it into a powerful tool to unlock the door to financial freedom.

During the 90’s Robert Kiyosaki shot to international acclaim with his series of books Rich Dad Poor Dad. The original Rich Dad Poor Dad was excellent for mindset but light on detail or the ‘how to’ that so many people are looking to uncover. If you’re familiar or not with the books doesn’t matter, the key take outs for me then and still remain to surround yourself with a team of great people, meet with them frequently and educate yourself on how to achieve financial freedom irrespective of the size of your income. A key part of this education is understanding good debt vs bad debt.

In simple terms, good debt is used for the acquisition of assets / investments that provide you a return on the investment. Think investment property – both commercial and residential – shares and the like. These investments should be strategically acquired to go up in value and provide a yield, or income, that justifies their purchase. Conversely bad debt is used to indulge in a consumer lifestyle or the purchase of items that go down in value. Examples of bad debt fuelled purchases include cars, motorcycles, cash advances from the credit card for a night on the town, creating a phenomenal wardrobe off the back of the MasterCard and I’m sure you can think of plenty of others. A very important distinction between good debt and bad debt is that you can normally claim a tax deduction for the interest costs associated with good debt and you cannot claim this for bad debt. I like to think of it as the tax man giving you a pat on the back for picking the better course of action.

You might be wondering what happens to those that understand the difference between good debt and bad debt and put that knowledge into action? Let me give you an example. I met with an individual in his 40’s who seemingly has an amazing lifestyle. He jets around the country and to all those that know him, they think he’s fantastically successful – he certainly talks the talk that’s for sure. The detail is not so rosy. Nearly $100,000 in credit card debt, bill defaults and the phenomenal stress that if one of the balls he has in the air falls it will bring the whole lot crashing down in bankruptcy. Conversely, I have a 27 year old client who talks to me weekly (at least). He started slowly and with smart decisions used good debt to acquire great investments. In less than 6 years he is very close to earning more from those investments than his wage. He now purchases property more than once a year (amongst other investments) and through the knowledge he has gained through his ‘team’ has started a business that will help others. He will keep using good debt and in the very near future will be in a position to choose whether to work for a wage or not because he simply won’t need it. It’s inspiring stuff.

Which path would you like to be on?

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