How To Use Debt To Get Rich

Dear Reader,

Many people teach that debt is bad or evil. They preach that it is smart to pay off your debt and to stay out of debt. And to an extent…they are right.

There is good debt and bad debt. It is wise to pay off bad debt—or not get into it in the first place. Simply said, bad debt takes money out of your pocket, and good debt puts money into your pocket.

A credit card is often bad debt because people use it to buy depreciating items like big screen TVs, cars, and vacations. 

Conversely, a loan for an investment property that you rent out can be good debt if the asset’s cash flow covers the debt payment and puts money in your pocket.

The people who preach the evils of debt do not understand that debt is essential to the American economy. 

Whether that is good or bad is debatable, but what is not debatable is that without debt, our entire economy would collapse. 

Our entire economy is based on steady inflation. And the way in which we encourage that inflation is through debt.

The way the rich use debt and the way the poor and middle classes use debt are vastly different.

The rich use good debt to grow their worth, and they invest in cash flowing assets using Other People’s Money (OPM)—both the bank’s and investors’.

In fact the ultimate goal for the super-wealthy is to never invest with their own money. They are masters of leveraging and raising capital.  

Debt Is A Form Of Leverage

Leverage is the fastest way to build wealth, but it is also the most dangerous. We often say debt is a lot like a loaded gun. If you use it without training and education, terrible things can happen. If you use it correctly and with your education, it can be a great tool.

Banks do not loan money for stock trading, but it doesn’t mean you can’t borrow money to invest in the stock market.

The Rich Dad philosophy is to use debt once you have become educated, not before. Leveraging money with good debt is something that should be respected rather than something that should be feared. The debt that people should fear is debt that must be paid off by working at a job.

Debt And How It Relates To The Stock Market

#1  Margin account

Like the real estate market, the stock market allows ample opportunity to use Other People’s Money (OPM). As a stock investor, you can take advantage of something that is called a margin account.

Buying stock on margin allows you to leverage your money in a way that’s little different than how a real estate investor would use a bank loan.

Buying on margin is borrowing money from a broker to purchase stock. Instead of getting a loan from your bank, you are getting a loan from your broker. Leveraging margins allows you to buy more stock than you’d be able to normally. This allows you to make more money and trade in greater volume. This also allows you to lose more money for the same reasons.

Remember, debt is not to be used lightly. It demands great respect and education.

To trade on margin, you need a margin account with your broker and you need collateral. Collateral is usually in the form of existing stocks you’ve already purchased. As with just about any loan, these are not free. Your broker will charge an interest rate. So if you are buying stocks for the long term, make sure the gains will cover the cost of extended interest rates.

Why use margin? The same reason real estate investors use debt: leverage. Leverage amplifies every point that a stock goes up. If you pick the right investment, margin can dramatically increase your profit. Pick the wrong one and it can dramatically increase your losses too.

#2  Short positions

Shorting a stock is simply borrowing someone else’s stocks, selling them into the market, and putting the money into your pocket. If and when the market price of the stock comes down, the investor buys the stock back and returns it to the person they borrowed the stocks from.

For example, let’s say XYZ Corporation’s stock price is $50 and the market is trending down. The following is a sequence of events involved in shorting a stock:

  • The investor calls his or her stockbroker and asks to short 100 shares of XYZ stock.
  • The broker then borrows 100 shares from another client’s account and sells the 100 shares for $5,000.
  • The broker then deposits the $5,000 into the account of the investor (who did not own the stock).
  • In the account where the stock was borrowed from, there is an IOU for 100 shares of stock, not for $5,000.
  • Over time, the stock price of XYZ drops to $40 a share.
  • The investor who borrowed the shares calls the stockbroker up and says, “Buy me 100 shares of XYZ at $40.”
  • The broker buys the 100 shares of stock at $40 and returns the initial 100 shares to the account that loaned the shares to the investor.
  • The stockbroker pays for the 100 shares from the $5,000 in the investor’s account. The $5,000 has come from the original sale of the 100 shares of stock at $50.
  • The investor has realized a $1,000 profit (less fees, commissions, and taxes) by selling shares of stock they did not own. The investor made money without any money. That is, in simplified terms, the process of shorting a stock.

There is tremendous risk in shorting a stock. A person can lose a lot of money shorting a stock if the market trends up and the stock price goes up. In this example, this same investor would have lost $1,000 if the stock price went to $60. But as rich dad often said, “Just because there is risk, does not mean it has to be risky.”

#3  Options Market

The options market offers us something more interesting than we can get with stocks alone. With options, we have the ability to leverage our money without going into debt at all. 

A stock option is a promise by someone to sell a certain stock at an agreed-upon price until a certain date. In return for this promise, he receives a premium as income. This premium is not just based on the movement of the stock price, but on the movement of time.

Stock options can be confusing so I’m going to use an example as it relates to real estate.

Let’s suppose that you are a landlord who owns a house. You find a family to buy the house, but they don’t want to buy it outright today. Instead, they decide to lease the house for three years with the option to purchase the house at an agreed-upon price at the end of the lease term.

While you are waiting for the lease to expire, you are earning money on the movement of time (rent).

As the owner of a lease-to-own house, you will make money no matter what happens. It doesn’t matter if the value of the house increases or decreases. If the house increases in value beyond the agreed-upon price, the family got a good deal but you still got what you wanted since you set the price.

If the house goes down in value, the family will likely not buy the house at the end of the lease and you get to keep the house.

Now you can go out and lease-to-own the house again. Rinse. Repeat.

While not exactly the same (you don’t receive payments during the term of the option contract), you now have a general idea of how a stock option works:

  1. You own Stock XYZ
  2. You sell an Option to buy Stock XYZ after a predetermined amount of time at an agreed-upon price
  3. At the expiration of the term, you receive the option premium.
  4. You either sell Stock XYZ at the agreed price or you retain ownership
  5. Repeat.

If you did not fully understand this, do not worry. 

In theory, it is simple and not hard to understand, if you spend a little time studying the subject. It is much like learning to eat with your left hand after spending your life eating with your right. It is simple in theory and simple once you learn to do it. It’s learning to think and do things in different ways that is sometimes hard.

To me, buying options to protect your assets makes sense. Selling options for cash flow is fun. One of the reasons I do not worry about money is simply because I know I can go to the market and make more money in minutes than most people make in months, and pay less in taxes.

Can everyone do what I do? Absolutely, but only if they are willing to invest some time in expanding their context and increasing their financial context.

Regards,

Robert Kiyosaki

Robert Kiyosaki
Editor, Rich Dad Poor Dad Daily

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Robert Kiyosaki

Robert Kiyosaki, author of bestseller Rich Dad Poor Dad as well as 25 others financial guide books, has spent his career working as a financial educator, entrepreneur, successful investor, real estate mogul, and motivational speaker, all while running the Rich Dad Company.

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