Tag: investment

Smart debt versus dumb debt

If you’re buying an asset that makes you more money (whether through appreciation, cash flow/dividends, or tax benefits) than it costs to borrow (paying down your principal and interest while more than keeping pace with inflation), you can make a legitimate argument to go into debt to invest in that asset.

If you’re going into debt to buy something that doesn’t make you money, you’re giving into your inner child.

Only borrow money to buy things that go up in value. Otherwise pay all cash for it or not at all.

Using cash or using debt?

Are you a “cash” only person (like Dave Ramsey) or do you prefer to utilize debt on your behalf?

Honestly, I see the pros and cons to both sides. Being more financially risk averse/conservative, I get the appeal of only using “cash” (or, even if I’m putting it on a debit/credit card, only buying what I can afford to pay at that very moment). It’s a safer position from the standpoint that you aren’t going to get yourself into massive debt. This strategy makes a ton of sense for those trying to minimize spending on things they don’t need (mostly consumer products that contribute to lifestyle creep).

But if you leverage debt to buy assets (like real estate), where someone else is paying the loan down for you, you can scale much more quickly.

Imagine wanting to buy a rental property. Let’s say you’re looking to buy a single family home for $120,000. If you have to pay cash for it, it will take you a long time to save up $120k. Even if you’re investing it, unless it’s in a self-directed IRA, when you pull your money out to purchase the property you’ll get hit with taxes. But if you only had to save up $30k (for a 25% down payment on an investment property) or even $4,200 (for a 3.5% FHA loan, where you have to live in the property for at least one year), you can get started much sooner.

Leverage works both ways. It can help propel you to success or drive you into the ground. But as long as you’re taking on appropriate risks (preferably starting small unless you have a ton of experience and expertise in what you’re investing in), you can build wealth at a greater pace by leveraging debt as opposed to paying all “cash” for everything.

What are your thoughts/how do you prefer to invest?

What to do with your money

First of all, let me say that I’m NOT a financial advisor. I’m not an expert with personal finances. I just like reading and learning about finances. The below “strategy” is not financial advise to anyone. It is only my current way of thinking about how I want to save and invest my money.

In The Richest Man in Babylon, they say that all people should pay themselves first and save 10% of any income they earn. I say, why not more? If you can optimize your life, it’s very possible to save more money without feeling deprived.

It all starts with having the right mindset (being grateful for what you have and not feeling like you have to “keep up with the Joneses”). You aren’t depriving yourself when you save at least 10% of your paycheck. You’re paying yourself and investing in your future. The first part of the saving should go towards your emergency fund. Once you have that, the savings should be invested (see where I like to diversify my portfolio below).

Second, you need to be intentional with where your money goes. It’s very easy to let your lifestyle creep up to the amount that you make. I remember when I got my first job out of college. I really didn’t make much. It was probably the equivalent of $35,000 for a year. But I felt RICH! After increasing my income, it would have been easy to increase my expenses too. But if I could live happily off of $35k per year, why should I not be able to bank the balance of the money when I make $50k, 80k, or more than $100k? Control your expenses and aggressively pay off all of your debts (with the possible exception being your mortgage).

Third, you need to beef up your investments. Have real, liquid cash for your emergency fund. Obtain credit lines if you don’t have a 3-6 month emergency fund, but keep in mind that credit lines are more like fake liquidity and can be removed at anytime. As far as investing is concerned, if you’re not an expert in a field (where you have a leg up on the competition), I think it is wise to diversify…

1. Some money in the bank (money market accounts, CDs, high interest savings accounts, no fee checking accounts)…this is your “emergency fund” and your everyday spending money. Don’t worry about optimizing your returns here. This is about convenience/accessibility.

2. Keep some money in stocks (primarily index funds…and cover different spectrums of aggression/conservatism, different countries- U.S. vs Europe vs developing nations, different categories – tech vs medical vs natural energy, different timelines, S&P 500, etc.).

3. Keep some money in real estate (your home and rental properties)…this is tangible. People always need to live somewhere. It would be nice to own these free and clear, but as long as they are cash flowing after all expenses are paid (including paying the principal, interest, taxes, insurance, and withholding money for capital expenditures, repairs/maintenance, vacancy, and property management).

4. Keep some money in bonds if you are more risk averse or getting closer to retirement (only in governments that you feel are strong and can repay the debt)…have a lower percentage of your money here.

5. Some money in a small business that you own/partially own (self storage, laundry mat, car wash, pizza chain, property management company, blog, or other “side hustle”).

Finally, after you’ve controlled your expenses, and invested what you can, try to increase your income by earning a raise at your current job, changing jobs/careers, or earning income off of a side hustle.

Thinking about diversification

Does diversification really make sense? I used to think, of course it makes sense! When you diversify, you are spreading out (aka minimizing) your potential risk. But you’re also minimizing your potential reward. So now, my thinking is…maybe. I think it depends on your level of knowledge in what you’re investing in.

Diversification for the novice investor can be thought of as risk mitigation, but for the expert in their field, instead of putting all of their eggs in the basket they know best, they would be putting some eggs in that basket and some in other baskets which they have limited information/knowledge on how to properly optimize their return on investment. An analogy would be to consider a generalist versus a specialist. A generalist might be a jack of all trades, but a master of none, just as diversifying your portfolio makes you “good” in several areas, but not excellent in any. This is because you have spread yourself too thin to truly become an expert in one area.

For the novice investor (which I am, so no judgement is being passed here), I think diversification makes sense. But if you are an expert in your field and you know something better than 99% of the population, why would you reduce your investment where you have an informational advantage? Does it really make sense to invest in things that you don’t know as well just so you are diversified?

Does a top-tier athlete try to go pro in multiple sports or do they eventually select one and try to be the best at that? When you are starting a business, will you get as far by trying to do a little bit of everything and serving every type of client or does it make sense to niche down and become the “go-to” person/business for one specific type of client? That’s where the saying comes from, “when everyone is your customer, nobody is.” You don’t differentiate yourself from your competitors who have either become the experts in their field or who have the name brand recognition and can afford to spread their resources thin.