Debt Free John on 26 May 2008 02:40 pm
If you read just about any book, blog or article on personal finance or financial freedom you’ll come across the concept of debt being either ‘good’ or ‘bad’. I disagree with this philosophy - there is no such thing as a good debt as taking on debt involves taking on risk (and as a entrepreneur bad debt implies someone has failed to pay me, which I never let happen). Instead I prefer to think in terms of:
- Wasteful debt;
- Enabling debt.
So what do I mean by these terms?
Wasteful debt is debt incurred buying products or services that:
- You do not need (or do not need such a premium version of);
- Result in a negative cash flow;
- Lose their value immediately/are impossible to resell.
A good example would be buying a top of the range executive car, you probably don’t need such an expensive car: a cheaper one would get you where you are going just as well, even if you never use it the car costs you money in tax and insurance and finally new cars lose a lot of their value as soon as you drive them off the forecourt - so if you sold it a week later you’d not be able to clear the debt.
Wasteful debts should be avoided as they waste your cash, reducing the cash flow you have available.
Enabling debt is debt that is incurred to enable you to create an income in excess of the cost of servicing the debt.
If the previously mentioned executive car costs £1,000 per month for the next three years but enables you to operate a executive taxi/chauffeur service that will turnover £4,000 and create a profit of £2,000 after costs (including any payments against the debt) then that debt has enabled you to create a positive cash flow of £2,000 per month.
In my opinion enabling debts are acceptable, wasteful debts should be avoided but no debt is ever good!