The old wisdom used to be that debt was the enemy, to be reduced at every opportunity. Have a mortgage or another loan? Pay that monster off: as much as you can, as often as you can!
But this approach isn’t as wise as it was when interest rates ran as high as 17% in the late 1980s. In fact, with current Australian Standard Variable interest rates well below 4%, it’s an excellent time to make debt less of an enemy and more of a friend, provided you have good financial habits to begin with.
Obviously, not all debt is bad. It allows us to acquire assets as part of a long term plan. It’s the rare person who could pay cash up-front to buy a house – we all rely on manageable debt to buy a home or other investments. As long as you aren’t overextending yourself – that is, taking on more debt than you can actually repay or spending much more than you actually earn – it’s a time-honoured and sensible way to build wealth and security.
A few weeks ago, we shared an article discussing the difference between good debt and bad debt and how to use debt recycling to build your assets and create wealth. That example is one way to use debt cannily to your advantage.
So what can you do instead of paying off your manageable debts?
One option is to put some of your savings into your superannuation instead of on the principal of your home loan. For example, paying $5000 off the principal may reduce your mortgage debt, but the savings made with interest rates so low aren’t as impressive as the gains of investing the same sum into your super fund, which can have annual returns of perhaps 7 to 9 per cent (and can increase over longer periods).
The correct measure of wealth isn’t cash flow but your personal balance sheet – that is, your assets minus your liabilities. Reducing your liabilities is one approach to increasing your wealth, but if you have developed good savings and investments habits, improving your assets can help you grow a lot faster.
If you want to learn more about how to use debt to your advantage, Louis will be sharing tips on our podcast, The Investor Exchange, over the course of the next weeks.