Learning from other’s mistakes

The opinion of many people towards debt can be best summed up in the often quoted line from Shakespeare, ‘neither a borrower nor a lender be.’ Yet others will embrace debt as one of the most important tools in their investment arsenal. Of course, successful debt management comes down to whether you control your debt or you let it control you.

Some see debt as their friend, allowing them to purchase everything from household goods to investments that they would otherwise not have been able to do with their own money. These people seek out the lender that will give them the most credit, on the best terms and become the winner by leveraging.

At the other end of the scale, debt can be seen as a necessary evil that we just can’t get rid of quickly enough. Some of us loathe having to borrow money even if it’s for something important like our first home. The date that the mortgage is finally cleared can be a day of much celebration.

However you feel about borrowing, a fresh look at your debt strategy and how it fits within your overall financial plan can be a very worthwhile exercise.

The dark side of debt

The dark days of the Global Financial Crisis are still a very recent memory of debt-linked financial troubles on a major scale. After all, much of the crisis is blamed on so-called “sub-prime lending” in the US, where homebuyers borrowed money they couldn’t afford to repay.

As conditions worsened we also witnessed many companies winding up due to not being able to service their large loans. A local example was ABC Learning, which had grown quickly by borrowing money to acquire new childcare centres but eventually failed to meet its bankers’ requirements.

When the Australian share market fell by almost 50% from its peak, we saw the devastating effects where margin lending had been used to buy shares. Many individuals, from mums and dads to high profile business people hadn’t built sufficient safeguards into their strategies and their leveraged position multiplied the impact.

On a more positive note

Taking into account your feelings about debt, it is worth thinking carefully about what it can add to your lifestyle or future financial goals. Of course, most of us borrow to purchase a home that we’d otherwise have to save for decades to buy outright. Many credit card purchases are made for the same reason.

From an investment perspective, debt can also mean making an investment you would not otherwise be able to afford immediately. Again, property is the obvious example and the decision is often justified by the expected long-term wealth creation benefits and tax breaks that can help along the way.

However, when it comes to many other investments, going into debt is often about the leveraging. For example, by borrowing to invest you can buy a larger share portfolio which gives you more diversification, thereby spreading the risk.

Other options include instalment warrants and internally geared managed funds that can give you different types of risks and returns.

So you see when managed well, debt can be an integral part of a successful investment strategy. Talk to your financial adviser to learn how you can best control and use debt in your own circumstances.

KK’s gut instinct

“Don’t leave off USA as a potential place to invest in property, although the AUD against USD will come off inside the next 6 months.”

Sporting tip of the month

Black Caviar will remain undefeated forever – is that some sort of oxymoron?  Call me with your thoughts on this or post a comment below!