Noel Whittaker's Blog Today we’ll talk about a strategy that can help you build wealth – borrowing.
Most Australians borrow – either for logical or emotional reasons. A logical reason is to buy a home now because you believe there will be long term growth – an emotional one is to get that latest big screen TV today because you must have it now and can’t wait to save up for it.
Debt, of itself, is not a bad thing – but you need to understand that there is bad debt and good debt. To know one from the other you need to compare the habits of the financial winners with those who are battling. The battlers borrow at high rates of interest to buy depreciating items that will be worthless in a few years – the winners borrow at low rates to buy growth assets such as property and shares which should increase in value.
The cream on the cake is that these assets produce extra income for you, while the interest on the loan used to buy them is tax deductible.
One couple decides lifestyle is a priority – they take out a personal loan of $30,000 over five years at 11% to buy furniture and appliances. Repayments are $652 a month which costs about $13,000 a year in pretax dollars. After five years they have spent $65,000 in pretax dollars and have nothing much to show for it.
Another couple borrow $200,000 to buy quality shares – the interest is $13,000 a year tax deductible, which means it is coming from pretax dollars. If the shares earn 9%, income and growth combined, the portfolio would be worth $308,000 in five years and will be generating enough income to pay the interest. Yes, there will be tax on the income from the portfolio but that will be relatively little in the scheme of things thanks to the franking credits. In any event any shortfall would be tax deductible.
Both couples spent $65,000 in five years – the ones who bought the furniture are probably still battling, the others have an equity of $108,000 in a portfolio that could now be left alone to grow while funding itself for the rest of their lives.