The Smart Ways to Use Debt to Build Wealth

Key Takeaways

• When debt is approached practically and strategically, it can be a formidable tool for investors and others for producing wealth and gaining financial success.

• Business loans can be used to build wealth by providing financial leverage and helping with the purchase of updated equipment, attracting top-shelf employees, gaining tax benefits, and preserving personal funds.

• Non-consumer debt, also referred to as “good” or business debt, can be strategically employed to fortify one’s financial position.

Many people think of debt exclusively as “bad,” as a liability, when it also can be leveraged for financial growth. The fact is that business loans, personal loans, and even credit cards can be used to one’s advantage, if employed the right way. Here are smart ways to use debt to build wealth.

What is Debt?

Debt is often viewed, generally due to lifelong conditioning, as something to be avoided at all costs. However, when it is approached practically and strategically, debt can be a formidable tool for investors and others for producing generational wealth and gaining financial success.

Having said that, debt is basically defined as a financial obligation to a financial institution or loan holder.  “Bad” debt generally includes consumer debt, speculative loans, and margin loans.

The Benefits of Using Debts to Build Wealth

When done responsibly, employing debt to build wealth can be a wise financial move. By using debt to invest in assets that appreciate, investors can prospectively gain better returns and reach their financial goals faster.

For example, there are certain types of debt, such as a mortgage used for a rental property, that can help generate a positive net cash flow and, over time, heighten assets’ value. 

Non-consumer debt, also referred to as “good” or business debt, can be strategically employed to fortify one’s financial position.

Then there are collateralized loan obligations – CLOs — that are single securities that are backed by a debt pool.

Types of Debt

There are various types of debt, each with their own potential benefits and risks. It is important to understand the primary kinds of debt and how they can be used. 

• Credit card debt. This is money that is owed to a card issuer for purchases made with a credit card. Missed or late payments can result in late fees, increased interest rates, and reporting to a credit agency. Even when payments are current, credit card debt can accrue heavy interest charges and have a deleterious effect on a person’s financial health. A zero-interest credit card, though, can be used for a period to consolidate and pay off higher-interest cards.
• Business loans. Business loans can be used to build wealth by providing financial leverage and helping with the purchase of updated equipment, attracting top-shelf employees, gaining tax benefits, and preserving personal funds.
• Personal loans. Depending on factors such as purpose and affordability, personal loan debt can be considered good or bad. For example, using loans for debt consolidation — wherein debts are rolled into one payment at a better rate — or for home improvement can be beneficial.
• Investment loans. Investment loans are generally used to buy an investment such as stocks or bonds. Depending on the type, such a loan can enable the investment of more than an individual might be able to otherwise handle. When the investment is sold, the loan is repaid, and the investor retains any investment growth, which could lead to accelerated wealth accumulation. However, just as prospective gains can be magnified, losses can as well.  

Strategies for Building Wealth with Debt

Depending on one’s risk tolerance and near- and long-term financial goals, there are a number of approaches one can take to use debt to build wealth – while one is in debt:

• Know your credit score. This is a wise place to start. One’s credit score is the chief way one’s creditworthiness is determined by lenders. For example, because debentures have no collateral backing, they depend for support on the issuer’s creditworthiness. Likewise, it is essential that every individual knows what their score is. Once that has been determined, credit card usage should be limited or adjusted accordingly. 
• Analyze your cash flow and long-term goals. To use debt to build wealth, it is necessary to analyze one’s long-term goals, which shapes strategy, as well as cash flow. The latter is important because it permits the identification of income sources, and how the funds are spent. Managing cash flow is essential to minimizing bad debt and increasing net cash flow.
• Pay off high-interest debts first. Carrying balances on credit cards can lead to substantial interest costs that outweigh any benefits. Thus, when reducing one’s debt load, it is smart to pay off cards with the highest interest debts first.
• Take advantage of various debt-use strategies. Such approaches can include increasing one’s mortgage payments to pay down that loan faster, leveraging interest-free promotional periods for high-interest credit cards, and utilizing offset accounts, which are transaction accounts that are linked to an investment or home loan. With such an account, the money can be used to “offset” one’s home loan balance, and the borrower must only pay interest on the difference.
• Develop an effective investment strategy. When using debt to grow wealth, it is important to develop an effective investment strategy. After all, borrowing money to invest in real estate, stocks, or other appreciating assets can prospectively generate higher returns. Developing an investment plan generally involves reviewing one’s finances, setting financial goals, researching investment options, understanding the risks, and building and monitoring the portfolio.
• Diversify your investment portfolio.  Alternative investments such as real estate, art, and transportation are increasingly popular because of their low correlation to public markets, which mitigates volatility. A chief benefit of putting capital in alternatives is portfolio diversification – the practice of spreading one’s investments among as well as within differing asset classes. Diversification can improve returns and limit exposure to risk. Rather than a 60% stock/40% fixed-income mix, a more modern allocation is 60/20/20. More on that later.

What Does Investing in Debt Mean?

There is a difference between investing with debt and investing in debt. The former means using existing personal debt to grow wealth, while the latter generally refers to debt investments made in collections of private or corporate debts and can include a variety of debts.

For example, the leading alternative investments platform Yieldstreet, on which nearly $4 billion has been invested to date, can help investors gain exposure to offerings in which one can invest in debt. Because debt investing provides exposure to varying types of securities, it helps with diversification, which is vital to avoiding big losses. In fact, a diversified portfolio is key to long-term investing success.  

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Investors and anyone looking to optimize their financial portfolio can use debt as a useful investment tool to drive financial growth, but they must be practical and savvy about doing so. Make certain one’s strategies are aligned with financial goals.