Folly or fortitude?

[percy]

Very clear to me KW.
Great post.

[Vaygor1]

.... Over time, your investments will a deliver passive income, which relieves you of the obligation to work hard.

I agree.

One can borrow (or not), be wealthy, and do a hard day's work. It's just nicer to have a choice in the matter.

[BIRMANBOY]

How does "rich dad" view borrowing to invest? I don't have any issue with his basic concept of saving and investing and not spending excessively although I do question the lack of importance you (he) have attached to education and good job. However that may be just in the details missing and is not really central to my original point.

I am. That is what the Rich Dad Poor Dad books are about. The author is saying that it does not take an education or a good job to be financially successful in life. All you need to do is save as much of your income as possible, and then invest it in either building your own business, investing in property, or the share market. Over time, your investments will a deliver passive income, which relieves you of the obligation to work hard. Its about building passive cashflow and using it to purchase more cash generating assets. He compares this to the average middle class consumer, who follows the normal path in life of "getting an education" (and a huge student debt) and then a "good job", but who then spends all their income so they can look successful and keep up with their friends/neighbours/colleagues (buying a big house with a huge mortgage, expensive cars, fancy holidays etc). These people blow all their money, so he sees the whole middle class as being poor rather than being wealthy (wealthy being defined as financially independent and not tied to working for a living). Very similar outlook and theory as espoused by the Mr Money Mustache blog.

With the exception of those who are living on a subsistence wage, everyone has room to make sacrifices and save money which they can use to invest in some manner, and so become a "Rich Dad". Even if you know nothing about investing you can save up to buy a rental property or put your money into a mutual fund, so its definitely not beyond the abilities of the average Joe. But the hard part, the part that takes effort - is the saving money bit. Most people on this planet prefer to spend it.

Hope that is clearer :-)

[Aaron]

Does the gain realised from borrowing to fund the purchase of shares outweigh the counterbalancing negative effect of compounding debt. Remembering that compounding magnifies the debt beyond its initial impact.

Simplistically, Yes if your share investment goes up no if it goes down.
Dividend income should hopefully cover interest costs so the debt doesn't compound.
Assume you borrow $500,000 to invest in shares assume also that dividend yields are the same as interest costs. All else being equal assume inflation stays at it’s recent average of 2.5%. Prices will rise with inflation so we could assume earnings rise at the rate of inflation and capitalisation rates and yields stay the same.

Investment 500,000
Loan 500,000
Dividend Income 35,000
Interest Cost 35,000
Investment Return 7.0%
Inflation Rate 2.5%
Number of Years From Now 20

Investment 819,308
Loan 500,000
Dividend Income 57,352
Interest Cost 35,000

Had this in a nice table but can't seem to get it to show right here.
In twenty years your investment has grown but your loan hasn’t, investment returns have grown so you are better off. Although if you have deflation your right in the crap and it is the reckless people who have borrowed too much that world central bankers are trying to save for some reason.
Save and invest in assets that generate a passive income. juice your returns with leverage but weigh up the risks first.
For that matter Birmanboy what level of debt will you put up with in the companys you are investing in. Return on Equity can be greatly enhanced by debt. It can also drive a company to bankruptcy when times get tough.

[BIRMANBOY]

What you mean like Team NZ? Seems to me that didn't go so well however I like to see some poetic analogies being used so good one...keep your lifejackets handy would be my only comment.

In my more whimsical moments, I've viewed investing as being much like building a boat. The hull is your equity and the sails are your debt. The object of the exercise is to optimize the design over time and trim the sails for maximum velocity without capsizing.

[BIRMANBOY]

So here comes the crucial question...what is investing...is it putting money into a product and or project that may or may not deliver a positive outcome? Is it investing when the positive outcome is not certain? Is there room for Murphy's law to influence your "certain" outcome? I don't consider any endeavour where the possible results are unknown or possibly a magnified disaster as being an "investment". It should realistically be called speculation. An investment should also have in its structure a limited downside...i.e. you can only lose what you put in. If I lose my own money that's one thing however if I lose the banks money not only do they want it back but they want interest on its use. So the downside is magnified excessively in my opinion. If one uses ones house as collateral and the "bad" occurs in an unusual or unlucky event then the repercussions can be catastrophic. "Works for some people", or "has worked for me previously" wont be much of a consolation.

It sounds like you have almost answered your own question. Borrowing to invest will simply magnify/amplify the end result be it positive or negative.



Agreed. There are never any guarantees. But which surgeon would you choose to improve your odds? The one with a good track-record or the one without?

[Biscuit]

...keep your lifejackets handy would be my only comment.

It's the people who don't learn to invest when they are young who end up all at sea without a lifejacket when they are old. In my view, appropriately managed debt can be an important part of investing. "Appropriately managed" may very well mean no debt at times, depending on many factors including your experience, situation and tolerance to risk. When things go South, you can easily drown in inappropriately managed debt.

[Aaron]

BBoy you want certainty in an uncertain world. I wouldn't mind betting there were a fair few from your generation who having cleared the mortgage and having saved some money took a conservative approach rather than the risks and speculation of the sharemarket and invested in finance company debentures as many would have been recommended to do by their financial advisors.

[BIRMANBOY]

Yes you absolutely correct Aaron...on both counts. Firstly as you get older the relative attachment one places on things like security, housing, medical issues and future ability to provide the necessary's when one is losing the capacity to generate income shifts. So as strange as it seems to younger people the certainty of a TD is a very attractive proposition. Imagine yourself in a situation where you cannot make a living and suddenly the whole outlook is shifted. As for those unfortunate folk who got burnt in sundry finance co's and Ponzi schemes you can see how they will appeal to those looking and or needing a few more dollars on their returns. So what is the common denominator of these failures? Financial innocence or naivety or just normal old human greed. All promising (and delivering in some cases) abnormally high returns. The higher the return, the greater the risk....simple but recurring theme in any and every financial endeavour.

BBoy you want certainty in an uncertain world. I wouldn't mind betting there were a fair few from your generation who having cleared the mortgage and having saved some money took a conservative approach rather than the risks and speculation of the sharemarket and invested in finance company debentures as many would have been recommended to do by their financial advisors.

[Biscuit]

So here comes the crucial question...what is investing...

Investing is realizing that there are no risk-free options and that everything is relative. Money in the bank carries a risk of losing value versus money in the stock market. You always have to manage risk.