Almost everyone has encountered debt at some point. Credit cards, car financing, mortgages and student loans are all part of the fabric of our lives.
Often, debt gets a bad rap and all debt is lumped together and considered inherently bad or undesirable. That can be an oversimplification that ignores the nuanced nature and potential benefits of certain types of well-managed debt. So let’s explore a bit about the world of debt, including both negative and positive aspects, and see why you might want to consider using what we call “intelligent leverage.”
The Apple Paradox and Other Lessons from the Corporate World
The corporate world has long understood the idea that debt can be used intelligently to help boost a business and amplify profits. In fact, there is a mathematical case for the use of debt in certain instances in the worlds of business and investing. When deployed strategically, debt can lead to greater returns than when avoiding it altogether.
A perfect example of leveraging funds to amplify profits comes from the world of private equity. We recently wrote about PE as an asset class and noted that a popular form of a buyout by PE firms is a leveraged buyout. This is where the purchase price for the transaction is largely provided by loans which use the target company itself as collateral. This technique allows for greater returns on the equity portion invested and demonstrates how maintaining a balanced approach can harness the mathematical power of debt for financial growth.
Let’s examine some quick math. Imagine a firm buys a company for $100 and the purchase price is $90 of debt (serviced by the target company from operations) and $10 of equity. If the target company is then sold for $110, the return on equity in the leveraged buyout is 100% (rather than 10% if purchased via equity alone).
Another notable example from the corporate world is tech giant Apple. Despite holding more cash than any other company, Apple still carries debt. This might seem counterintuitive at first, but it highlights a strategic financial move. Apple leverages debt to fund various initiatives, take advantage of tax benefits, and optimize its capital structure. The lesson here is that even financially robust entities recognize the strategic advantages of judiciously using debt as part of their overall financial strategy.
The Good Side of Personal Debt
It's crucial to distinguish between different types of debt. While consumer debt that leads to living beyond one's means is undeniably harmful, there are instances where debt can be a tool for financial convenience.
Take credit cards, for example. Using a credit card for recording spending, avoiding the need to carry cash, and enjoying a 30-day float are just a few of the positive aspects associated with responsible credit card use. When used prudently, credit cards can enhance financial flexibility and offer rewards (think of all those airline miles), making them a valuable financial instrument.
Debt might actually provide useful tax planning opportunities. Governments often encourage homeownership through various incentives, including tax deductions on mortgage interest. For example, government policy serves as an incentive for individuals to invest in real estate. By allowing homeowners to deduct mortgage interest when itemizing taxes, the government aims to promote the stability and growth of the housing market. This is an example of how debt, in the form of a mortgage, can align with both personal and societal financial goals.
At ASE, our approach to working with clients to maximize their use of these incentives is a program we call Government Incentive Monetization™. You can learn more about Government Incentive Monetization™ by reading this piece.*
Balance Sheet Capital™ for Financial Flexibility
Balance Sheet Capital™ (BSC™)* is a proprietary ASE financial concept we implement with our clients that emphasizes maintaining a healthy balance between assets and liabilities. By doing so, individuals and businesses can have lines of credit available for various purposes. These lines of credit act as a financial safety net, providing resources for opportunities, emergencies, and avoiding the need to liquidate assets.
Additionally, BSC™ allows for strategic planning, such as paying taxes without the immediate need for cash, showcasing the importance of a well-managed balance sheet.
What To Do?
Adopting a nuanced perspective towards debt empowers individuals to make informed financial decisions, leveraging debt as a strategic tool for growth rather than a hindrance to prosperity. A holistic understanding of debt, coupled with prudent financial management, allows individuals to turn the tables, transforming debt from a perceived burden into a catalyst for financial success.
- Strike the Right Balance. Rather than viewing debt through a one-dimensional lens, individuals should assess their financial goals, risk tolerance, and strategic opportunities.
- Manage Debt Practically. Implementing practical steps for debt management is crucial. This includes creating a comprehensive budget, distinguishing between good and bad debt, establishing an emergency fund, and developing a long-term financial plan.
- Education is Key. Understanding the terms of loans, interest rates, and the impact of debt empowers individuals to make informed decisions. Accessing reputable financial resources and seeking advice from financial professionals such as those at ASE Private Wealth™ contributes to building a strong foundation of financial knowledge.
- Embrace Resilience. Financial resilience allows individuals to weather unexpected challenges and seize opportunities for growth, creating a robust financial foundation. Building financial resilience involves not only managing debt responsibly but also adapting to changing circumstances.
Break Through the Myth
Debt should be viewed as a tool that can be harnessed for both positive and negative outcomes.
By understanding the nuances, leveraging debt strategically, and incorporating concepts like BSC™, individuals can navigate the financial landscape with greater confidence. It's time to debunk the myth that all debt is detrimental and embrace a balanced approach that maximizes the benefits while minimizing the risks.
At ASE Private Wealth™, we work with our clients and their professional advisors, such as tax and legal professionals, to identify and navigate opportunities and obstacles to create a bespoke action plan to most effectively meet their goals.
*Government Incentive Monetization™ (or GIM™) and Balance Sheet Capital™ (or BSC™) are proprietary concepts created by ASE Private Wealth and not industry terminology.