A quick introduction to Debt [Finance Fridays]
One of the cornerstones of modern society- but schools never taught us about it.
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I’ll tell you something that will shock a lot of you- Debt is a huge part of our economy. In fact, it is fair to say, that without debt the economic systems of our world would look significantly different. When it comes to finance content online- most people villanize debt a lot- treating it as something to avoid at all costs. However, there is a lot more nuance to debt than that.
In this article, I will be covering some of the most important fundamentals of debt. We will cover why Debt is important to the economy, the difference between good and bad debt, and how Debt can actually be a good thing. We will finish off with why Tech and Debt go hand in hand.
Key Highlights
Why Debt is Crucial to the Economy- Debt is important in our economy because it can be used to finance public and private investments that boost economic growth and productivity. For example, federal governments can borrow money to fund infrastructure projects, education, health care, and national defense, which can create jobs and increase the quality of life for citizens. This adds money to the economy, and the increased productivity can help the government pay back the debts without issues. Similarly, private businesses can borrow money to invest in capital goods, such as machinery, equipment, and technology, which can enhance their efficiency and profitability. Overall, the availability of Debt allows government or companies to expand their operations, which is vital to keep the economy going. We covered this idea in the article on the Boom and Bust Cycle and how it affects Tech. A similar principle applies to individuals taking business/student loans since the hope is to grow income faster than the ROI.
Good Debt vs Bad Debt- Good debt vs bad debt is a way of categorizing different types of debt based on how they affect your financial situation and goals. Generally speaking, good debt is debt that helps you increase your income or net worth over time (two examples mentioned above), while bad debt is debt that costs you money and reduces your financial opportunities. Examples of bad debt can be taking Debt to buy luxury goods, to finance marriages (a huge problem in India), or any other unnecessary expenses.
How you can leverage debt to your advantage- There are some interesting ways that you can use Debt to your advantage-
Use Credit Cards to pay the bills- You can use your credit card like a debit card (not spending more than your budget). This allows you to build your credit score and earn some pretty sweet rewards, essentially for free. However, keep in mind that credit card interest rates are crazy. If you miss a payment- it will cost you. This is why it is important to never cross your budget and set up autopay to keep your credit card balance clean.
Using Loans to Pay Back Loans- Let’s say that you take a very high-interest loan (interest rates are fairly high right now). You’re smart, so you make your payments on time, and thus your credit score stays great. When the interest rates fall, you will be eligible for a loan with great rates. So you take a new loan, use it to pay off the high-interest-rate loan, and then start enjoying the lower rates. You can also do this by taking a giant loan to pay off multiple loans- a strategy called Debt consolidation.
Loans as Tax Write-offs- Many kinds of loans are tax-deductible. Say you paid 5000 dollars of interest on student loans. You can legally use some of this to reduce your taxable income, saving you some money. Governments use this as a tool to encourage people to do certain things (start a business, buy homes, go to school, etc), and if you already have started one of these activities, than you should leverage it.
Keep in mind, that this must be done as a strategy. Don’t just go and take loans for the heck of it. Always consult real financial experts before you choose this.
Why Tech and Debt go so well together- You will notice that Tech Companies are well known for having a lot of debt. This goes back to the nature of tech. Often tech companies only make money at scale (Facebook is a worthless company if only 100 people use it). Debt/Investor money is what allows these companies to reach those heights. However, this acts as a double-edged sword. Tech companies often have obscene valuations and continue to balloon up, without any path to profit (Uber is a perfect example of this). These companies can look great when money is cheap, but in hard times they crash hard- leaving ordinary investors and their employees struggling. I covered why certain Billion Dollar Companies go bankrupt in days and Why this hurts regular folks like us in this article. As possible employees/investors/partners in these companies, it is important that you learn to recognize which companies have an actual path to profitability.
Hopefully, this taught you something about this very important but misunderstood topic. Do you have any experiences with Debt (good or bad)? I’d love to hear them.
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