Leveraging Debt to Get Rich

The basic idea is straightforward: you take out a loan and then utilize that money to invest in a cash-generating asset. The investor gets to retain whatever is left over after the loan has been paid off by the cash flow. Although the use of leverage is most often seen in the realm of real estate, it may also be seen in a wide variety of other asset types.

One from the actual world is as follows: When I say that I invest strategically in private equity, what I really mean is that I engage in leveraged buyouts of privately held companies. My primary concentration is on the lower middle market, sometimes known as the “sweet spot,” which is defined as the point at which a company is big enough to warrant the employment of a management team but not so large that it invites competition from larger private equity companies.

This maintains prices at a level that is acceptable, which in turn makes it possible to comfortably pay the debt. The majority of individuals go into debt in order to pay for things that they either do not want to or are unable to pay for in full at the time of purchase. This is the most common reason for people to take on debt.

A significant portion of this is what is known as consumer debt. Purchases made with a credit card that are not paid off in full at the end of each billing cycle are examples of this form of debt. Other examples include mortgages, auto loans, and student loans.

The receipt of cash flow as a result of this borrowing of money is not guaranteed. If you take on debt to purchase furnishings for the property in which you already reside, it is quite unlikely that you would utilize that loan to produce positive cash flow.

When using leveraged debt, an individual agrees to let another party pay off the debt that he has incurred. When it comes to normal debt, the person who racked up the debt is the one who is fully accountable for paying off the debt. However, this individual often does not have a strategy in place to have the debt paid off other than to take care of it at some time in the future. When it comes to leveraged debt, the business owner never would have taken on the obligation if they did not have a strategy in place to utilize the acquisition as a way to create the funds necessary to pay back the loan while also turning a profit.

In addition, there is a direct connection between the amount of debt that is committed and the amount of cash flow that is produced when using leveraged loans.

The best illustration of this would be to invest in property with the intention of renting it out. In order to accomplish this goal, the business owner does the necessary research to ascertain how much money will be required for the residence in the form of monthly mortgage payments, taxes, insurance, as well as maintenance and upkeep. After that, she decides whether or not she can set a rent that is sufficient to both pay those expenditures and produce some profit.

If the numbers work out in your favor, purchasing the house to utilize as a rental property might be a smart financial move. The cash flow that will be created by the rental revenue is directly tied to the cash that was used to acquire the house and the debt that was committed to buy it.

That is not how the wealthy grew to be so wealthy.

The financially ignorant poor rely on credit cards for their livelihood and mistakenly believe that playing credit card games would improve their riches. The wealthy are far less likely to make any use of credit cards at all and are much less likely to have a vehicle payment, but they are much more likely to make use of credit when purchasing a home. It is like comparing apples and oranges. The only people who will tell you that the two ideas are connected are bank employees, and they are trying to sell you something.

Rich people are less likely than poor people to use their non-discretionary funds to buy depreciating assets and consumables. However, because rich people have a much larger amount of discretionary funds, they are able to invest more in riskier instruments such as debt without increasing the amount of actual skin in the game.

To put it another way, if you take a wealthy guy and put him back into bad circumstances, you will find that he is more likely than a poor person to take the steps necessary to “get out of debt.” When the time comes, he will be prepared to take risks, but under no circumstances should you believe anybody who tells you that the affluent became rich by gambling with their credit. There is a vast army of behavioral psychologists whose job it is to trick people like you into thinking that they can “improve their credit score.” People that have a lot of money from their ethnic background are not easily fooled.