Thread by @JE_dna

Have you ever wondered why rich people borrow a lot?

Have you ever wondered what Finance people mean when they say debt/credit is a great tool for building wealth?

Well here's a simple explanation in this thread:

If you want to read this thread in a single post or share with

someone that doesn't use Twitter, here's a link to the article on my LinkedIn newsletter where I breakdown similar Finance topics into simple terms: linkedin.com/newsletters/th…

The dream financial position for some people to be in is "debt-free". But is being debt-free always the

best position to be in? Are there some benefits to having debt?

The first thing you must recognize is debt/credit on its own is neither bad nor good; it is what you do with debt that makes it so. Good debt is simply when you borrow to buy an asset that pays more than enough

to cover the interest from your debt. An asset is anything you own that can bring you money now/in the future. Your car/laptop is an asset if you use it for business purposes to earn more money. Your mind is an asset if you can use your ideas to add value & make money. To a model

their image & likeness are assets.

Bad debt is when you borrow for that which cannot generate future profit. When you borrow to invest & the profit you make from investing is more than the cost of repaying your debt, then that's good debt.

There's a full example of this thread

So how can you use debt to build wealth?

The popular phrase "you need money to make money" comes into play here. If you could invest in something that guarantees 10% return irrespective of how much you invest, and you could either invest 100k or 100m, which would you prefer?

Obviously 100m, why? Because 100m could make you 10m in profit while 100k would only make you 10k in profit. The more money you have at your disposal, the more money you can make. When you need money for personal use, your options are: draw from savings/investments or borrow. The

savings/investments you have are very limited to what you earn as such if you want more money to invest, you need to borrow. Back to our scenario, if you have 50m of the 100m you would like to invest & you can borrow the remaining 50m at 7.5% interest, should you invest the 50m

you have or borrow 50m to get 100m to invest?

Let's look at the math; if you invest your 50m, you will get 5m in profit which is 55m in total. While if you borrow the extra 50m, you would have 110m in total after the investment pays out. Remember you have to pay back the loan,

so you pay back 50m, which is the amount you borrowed and 3.75m, which is the 7.5% interest on the loan. This leaves you with 56.25m, which is more than the 55m you would have had if you invested just your money.

For a business, Publicly listed companies can get money from their

profits, from issuing shares to the public and borrowing. However, there is a limit to the amount of profit they have so if they need more money than their profits can cover, they might have to look elsewhere. The next option would be to issue more shares. But this option would

mean that they would have more owners (dilute ownership or "more cooks in the kitchen") and some companies may not want this because as they get more shareholders, it could make it more difficult to arrive at decisions. It could also affect the quality of decisions that they make

Also, there are other costs with issuing shares such as paying for underwriters etc. and issuing more shares could affect the share price of the company because again remember the principle of demand and supply, if the company issues shares and there are not enough buyers looking

to buy, this might cause the price of the company shares to fall, and they might not be able to raise the exact amount that they need. So, the next best option is to borrow.

If a company can borrow at an interest rate that is lower than the profits they expect to get in the

short/long term, then debt would be a great option because they could increase their profits & "return on equity (ROE)" which would be good for their share price. Remember, ROE is net profit divided by shareholder's equity. If the net profit increases & shareholder's equity

remains the same, then return on equity would increase.

In summary, the benefit of debt is you can use someone else's money to increase the size of your business and increase your profits while paying them interest.

How can you start using debt?...

To be continued in another thread

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