You probably heard the old saying ‘you need money to make money’. With that in mind, debt these days seems to be very acceptable – let’s face it, not many of us earn enough to buy a family home for cash, so it is understandable that we will go into debt, but not all debts are good to have! To understand the difference, you first need to understand what assets and what liabilities are, and to understand how to utilise good debt you also need to understand how income, assets and cashflow work together.
So first things first, what are assets? Technically speaking an asset is any item that has an economic value and can be converted into cash. However to be able to clarify good debt and bad debt we have to add, that an asset is anything that will increase in value over time. We can even go as far as stating that an asset generates income, whether it is cashflow or capital gains.
In that case, liabilities are the exact opposite, they decline in value and cost us money.
With that in light it should make it clearer that bad debt is money that you borrowed against items that decline in value, such as cars, credit card debt, shoes and the like. And good debt is money that you borrowed to use for income producing investments, such as rental property, business, shares.
If we take this further we can also find that good debt gives us tax deductions, as the interest you pay on these loans are tax deductible – also many other items relating to this asset could be, check with your tax department! Whereas bad debt is not tax deductible, not only that most bad dabt comes at a hefty price tag of high interest rates!
So with all this in mind, how can you use this knowledge to become wealthy? If you have ever read Robert Kiyosaki’s book Rich Dad, Poor Dad, you learn about the Cashflow Quadrant. In this Kiyosaki explains that the ‘poor’ – really they are just people with limited beliefs around money – stay poor because they choose ’employment’ and ‘self employment’ – where they swap time for money – to create an income. They have a belief that you have to work more to earn more and it can be only done through your hard work. They often work long hours, and believe that investing and business are ‘dangerous’.
Oposing to this we have Business owners. They are are on the Rich scale as long as they figured out that being a business owner means you have others working for you, and you spend your time in areas where it is worth the most! Look at Bill Gates.
The best quadrant to be in however is Quadrant four, which is where Investors sit! Investors do not work for money, they make their money work for them instead! These people have reached financial Freedom as they have several income streams, and these income streams are passive, meaning that once they are set up, they bring in income even when you are sleeping. Investors invest their money in appreciating assets. Not only that, they find other ways to leverage, they often use other people’s money to work for them also.
One of the major opposing differences between the Rich and the Poor quadrants are core values. The poor often values ‘job security’ whereas the rich value ‘financial freedom’ and find the way to make it happen. The other differences often found in people is the ‘keep up with the Jones’ syndrome’. Whilst the rich tend to hold off on gratification till they can afford it, the poor has a tendency to overspend on items not needed to keep up appearances/
So which side are you on? Are you the creator of bad debt, keeping you poor, or are you on your way to become an investor, making money work for you?
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