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The Power of Debt

Debt is often a 4-letter dirty word in the Asian context.  We are taught from a young age to spend within your limits, and to never dabble in debt.  Pay back quickly what you owe, lest it spirals out of control and land yourself in financial hot soup. It’s no wonder in my mortgage business, we see many people opting to pay down on their loans.

That’s all wise thinking when it comes to spending and not seeking instant gratification.  But what about using debt for investments?  Do we even stop and differentiate between the two uses of debt?  Are they the same? Do you just apply the same yardstick?  And should you look at debt with the same disdain even when it comes to boosting your returns from investment?  Certainly, the rich does not think so.

Debt is always a difficult topic to discuss due to this exact taboo it connotes.  The best way for me to explain this is by way of a fictitious example:

The “Everyone Wins” Story

Imagine you have a small sum of $50,000 set aside for investment.  It’s not always that you could get risk-free fixed deposit rates at 3% to 4% today, yet that’s still barely enough to cover red-hot inflation in the past years.  The problem is it’s a catch-22: Even when inflation falls back at some point, banks will surely lower the interest rate even more such that your real returns might still be zero or even negative.  You spoke with five other close friends who couldn’t agree more with you on your observation.

With a spark of creativity, here’s the interesting deal you propose to them which they are more than happy to accept: Each of them will lend you $10,000 for a period of 10 years, to which you promise to pay them a fixed return at 5% every year, i.e. $500 per year.  If your credibility is as rock-solid as the Singapore government, this is the best risk-free deal on the table that surpasses even the Singapore’s 10-year bond rate.  Of course, you’re not.  So, to sweeten the deal, you agree to pay back your friend in tranches of $1,000 per year, so they can get their capital back progressively instead of in a lumpsum at the end of 10 years.  This reduces their risk, yet you promise that they will still earn that 5% return from you every year until the 10th year!  Wow.. all your friends would agree that’s a deal too good to refuse.

So, what do you do with the total of $50,000 equity plus $50,000 of borrowed money?  Imagine you discover a way of achieving a steady 10% return on a total of $100,000 capital with minimal risks involved.  Here’s what you will do:

Total capital invested = $100,000

Per Annum Basis:
Total return (10%) = $10,000
– Paying your friend the interests ($500 x 5)= $2,500
– Paying back the principal (5 x $1,000)= $5,000
– Your net return per year = $2,500  
      

With just $50,000 of your own equity money, you achieve a net return for yourself of $2,500, which is also a 5% return on capital each year!  That’s much better than depending on the whipsawing fixed deposit rates which does not even peak at 5% but stays languishing in the 1.5% to 3% for most years.

That’s not all.  Here’s the exciting part – after 10 years, you would have paid back all your five friends which means from the 11th year onwards, you start to pocket the entire gross return of $10,000 per year, for as long as you stay invested!  On the original capital that you started with at $50,000, that’s an incredible yield of 20%!

Without the power of that additional $50,000 borrowed money to kickstart the whole scheme, you would never be able to achieve that financial outcome of a cash-printing ATM machine after 10 years, one which dispenses $10,000 of free spending money each year!  And if you can just put in place three to five of such “ATMs”, you are pretty much all set up for retirement.  To do that, don’t worry, you won’t need to go ask 25 friends for $10,000 each.  Banks can lend you this money with a much lower rate on the safest and cheapest leverage you could ever attain – a home equity loan.

By leveraging the power of good debt, everyone is a winner in the story.  You gotten yourself your steady 5% yield in the next 10 years regardless of the interest cycle.  So does each of your close friend, as you keep to your side of the deal.  Of course, you are the ultimate winner with a passive income of 20% return per year after 10 years, but that’s wholly to your credit of asking for money, to make money.

By now I hope you see the two sides of debt.  Don’t just associate debt with frivolous spending and all the vices that come with it.  Do what the rich does all the time – if you can invest wisely using OPM, or Other People’s Money, do that.  Leverage can boost your return fabulously.  Caveat is, to be fair, I have to tell you the flip side –  it can also magnify your losses!  There will always be risks in life.  In fact, all things which are worthy of pursuit involves risk, be it money-making, travel, career change, even love!  Rather than paralysis in life, assess the risk and put in place some risk management strategies.

I know what you’ll want to ask next – what’s this magic investment that could deliver 10% rock-solid returns with acceptable risk, which no one has ever told you before? (hint: it’s not some new unproven shiny object, but something found and verifiable right here in Singapore. Not a scam for sure)  For that, grab my book Mortgage-Free in 6 Years.  You won’t regret it.

This blog seeks to improve financial literacy amongst Singaporeans and provide the “best-in-class” knowledge for financial planning to help achieve the best retirement plan.  We also hope to become the conduit to channel funds from the well-to-do in this country to the poor and weak as part of our social mission.

ACTIONABLE STEPS AFTER READING:
1. Have a discussion with your spouse or close friends on what does debt conjures up and if that mindset has played a limiting role in your financial success
2. Brainstorm what are some risk management strategies you could look into, should you decide to leverage on debt to grow your return and your wealth
3. Find out more about this wonderful investment vehicle that could deliver 10% return per annum by getting a copy of Mortgage-Free In 6 Years!  You won’t regret it. 

Disclaimer: Neither PropertyWise Pte Ltd, the operator for this website, nor any of its editorial team writers or external contributors are in the business of providing financial advice. We are not licensed or regulated by MAS under the Financial Advisory Act (FAA) in Singapore.  All information presented are opinions of the writers and any representations given, whether by way of example, illustration or otherwise, are purely portfolio allocation advice and not recommendations or inducements to buy, sell or hold any particular investment product or class of investment product.  All opinions are generic in nature and are not tailored to the particular circumstances of any reader.  Seek advice from a qualified financial advisor before making any investment decision.

Though every effort has been made to ensure the accuracy of the information and figures presented, we make no representations or warranties with respect to the accuracy or completeness of the contents in this blog and specifically disclaim any implied warranties or fitness for a particular purpose. You are advised to validate the information especially content related to CPF retirement account and CPF Life.

We shall not be held responsible for any financial loss or any other damages suffered whatsoever, directly or indirectly, if you choose to follow any of the advice or recommendations given in this blog.

Darren Goh
Darren Goh
Author, Strategist, and Contrarian Property Investor in Singapore

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