Rich Dad Scam #7: “All Debt Is Bad”
Today’s is the seventh issue in your series on Rich Dad Scams—lies perpetrated on the poor and middle class by the rich.
If you’ve been following along, you may see some patterns in Rich Dad Scams. Several of them go together, and they all come from the same mindset.
Saving money, living below your means, and this Rich Dad Scam, “All Debt Is Bad,” all come from one place: fear of money.
Just like all the other scams, the idea that you have to eradicate debt from your life to be successful is a lie, and it gets repeated because people don’t have a financial education. They don’t understand what money actually is, how it works and how to put it to work.
There’s no doubt about it, from an early age we teach our children the value of saving money. “A penny saved; a penny earned,” we chime. And when they are a bit older, we spin tales of the magic of compounding interest. Save enough, children are told, and you’ll be a millionaire by the time you’re ready to retire!
That was Rich Dad Scam #5: “You Need to Save Money.”
But, we don’t tell them about historically low interest rates, or the power of inflation to eat away at the value of money over time… we may not even be fully aware of these inconvenient financial truths ourselves. These realities cheapen millionaire status every single day.
It seems as if the “wisdom” to save your money is timeless, in that it won’t go away, even though it’s proven to be wrong. Even today you find “financial experts” who push the save to be a millionaire myth.
Playing with Numbers
Take for instance this video shared on Business Insider, “How much money you need to save each day to become a millionaire by age 65“. Breaking it down by age, it gives the following amounts:
- Age 55: $156.12 per day / $56,984 per year
- Age 50: $73.49 per day / $26, 824 per year
- Age 45: $38.02 per day / $13,879 per year
- Age 40: $20.55 per day / $7.500 per year
- Age 35: 11.35 per day / $4,144 per year
- Age 30: $6.35 per day / $2,317 per year
- Age 25: $3.57 per day / $1,304 per year
- Age 20: $2.00 per day / $730 per year
If you’re in your twenties or thirties, you’re probably feeling pretty good about these numbers. You might even be tempted to think it’s worth it to start saving your money. After all, who doesn’t want to be a millionaire by the time they’re 65?
If you’re in your forties or fifties, you’re probably looking at those numbers and feeling a huge pain in your stomach. I don’t know many middle class families with an extra $10K to $56K to save each year.
Now, here’s the kicker, at the end of the video, the following assumptions (or should I say disclaimers?) are given:
“For simplicity sake, the calculations assume a 12% annual return and don’t take taxes into account.”
That indeed is some magical compounding interests-and mythical too. Let’s break this down a bit.
What’s a realistic return?
In the last 30 years or so, there has only been one time where interest rates on CD’s reached 12%. That was for a 5-year CD in 1984. Over the last decade, the S&P has only returned 8.65% on average. In the same time period, the 3-month T-bill has returned 0.74% and the 10-year T. Bond has returned 5.03%. In fact, if you look at this chart by Aswath Damodaran, you’ll see that since 1928, you’ll be hard-pressed to find any standard investment or savings vehicle that returns 12% over a sustained period of time.
Perhaps you’re ready to concede the point that 12% is lofty in terms of return assumptions, but maybe you’re still pretty comfortable with the idea of a 10%, 8% or even a 6% return.
The problem is, not only does the video assume a high rate of return that most people will never achieve, but it also does not factor in taxes, which can eat up significant portions of your returns.
For instance, savings account interest is taxed at a marginal rate. This simply means that it is taxed at your income bracket. So if you’re taxed at a 25% rate for your income of say, $65,000 a year, you’re savings interest earnings are also taxed at that rate.
You can begin to see how this pop financial advice begins to quickly fall apart.
Savers Are Losers, but Who Is the Winner?
For years, I’ve preached that savers are losers. Hopefully the examples above will open your eyes as to why.
But the question becomes, why would financial advisers continue to push savings? As always, follow the money. The traditional vehicles by which most people save allow for financial institutions to charge fees. These fees can be especially devastating to a retirement account like a 401(k).Take this example from “USA Today”:
Let’s say, for instance, you save $10,000 a year for 30 years in your 401(k). If you average 7% returns annually and pay 0.5% in annual expenses, you’ll finish with about $920,000 saved. However with 1.0% in annual fees, that total drops to a little less than $840,000 – and if you suffer 2.0% in annual fees, your finishing total is just under $700,000.
Adding them all up together, lower returns that most models assume, losses to taxes, and payouts to financial institutions in the form of fees completely decimates the assumptions made by the Business Insider video, and frankly, most savings models out there. Savers truly are losers, and it’s the financial institutions that win.
So, if savings isn’t the way to become rich, what should you do?
The short answer is take out loans.
Isn’t Debt Bad?
The Rich Dad Scams we identify are the ways the rich stay rich and make sure the poor stay poor.
That can be counterintuitive, especially when some of the scams—like living below your means and saving money—seem like they would help you get rich. But that’s the scam.
The rich carry debt. They generally carry a lot of it. But they have assets that more than make up for the outstanding loans the carry.
In fact, the rich not only carry debt, they also use it to get richer.
The difference between the rich and poor when it comes to debt is understanding the difference between different reasons behind carrying it.
There’s Good and Bad…
The bad kind is the one that makes you poorer, such as overdrawn credit cards, car loans, and so on.
This is the type of loans used to buy liabilities.
Good debt is the kind that makes you richer, such as a loan for investment property or to purchase equipment for your business that will make you a return.
This is the type of loan that is used to buy assets.
An easy example of good debt is my real estate holdings. By getting a loan from the bank, I can purchase a property with only a small percentage out of my pocket. I then rent that property and my tenant pays the cost of the my loan while putting money in my pocket.
Business is the same as the real estate example.
You can take out loans that pay for themselves. The cash flow of your business covers the what you’ve borrowed and generates income. That income can be turned into more good debt to create more cash flow.
We’ve been taught to think of debt as a four-letter word, but it doesn’t have to be. Especially once you have the financial education to see how it can work for you instead of against you.
How Money Works for You
Let me give you an example of how the good debt concept works…
Say I have $100,000. Maybe I inherited it, or sold something valuable. But I have this money. I can put it into a mutual fund, which is a little better than saving it—as long as I choose a good mutual fund that won’t take a huge chunk of the profits while also earning me extra taxes on capital gains. The return on it would be a bit more than just putting it in savings, but it won’t be a lot.
However, if I use that $100,000 as a down payment on a $500,000 property, then I’ve actually bought $500,000 in value with just $100,000! The difference, that $400,000, is good debt.
This is exactly what my wife Kim did on a smaller scale with her first investment.
She bought a $45,000 house with a $5,000 down payment, acquiring $40,000 in good debt, and she put that property to work.
The tenants paid the mortgage and the taxes on it for her. She was profiting, or generating a positive cash flow of $25 a month. It wasn’t a lot, but it was a start. She used the same practice over and over again, and she kept putting that money to work. Today, she invests in millions, but the concept is the same.
Today, rather than buy into “All Debt Is Bad” scam, I encourage you to instead increase your education and begin learning how you can make loans work for you.
Play it smart,
Editor, Rich Dad Poor Dad Daily