This article is in continuance to my earlier article.
In this article, I’m posting a descion making flow chart for a financial leverage decision – to take a loan or not to take a loan.
Some Definitions & Footnotes
Loan = Debt = Leverage
For the purpose of this article & most of my other articles and tweets,
Loan = Debt = Leverage
I use these terms interchangeably. Leverage is an instrument of gaining more with less! While the term leverage has origins probably in Physics it is now used in a more generic way. Debt or loan is a subset of leverage; they are the financial manifestations of leverage.
Asset & Liability
I’ll avoid the definitions from the domain of accounting. I’d rather use the “Rich Dad Poor Dad” version.
Asset: An asset is something that puts money in your pocket.
Liability: A Liability is something that takes money out of your pocket.
Those who stay busy acquiring assets, get into a financial virtuous loop and break out of the middle class. Those who stay busy acquiring liabilities (a lot of time actually thinking they’re assets!) stay middle class (financially & attitudinally).
Good to Own
Something which is owned for attributes which are beyond pure functional, and therefore may be good to own, but not necessary. An extreme example can be a Yacht or a private jet; a more common example can be owning three pairs of running shoes, one matching with each running jersey you own, when you can easily satisfice with one standard white pair.
Must Own
You guessed it right. They are “must own” – You must have them, like a mobile phone. However, sometimes we tend to justify our temptations by fitting good to own stuff in the must own category. You need to be careful especially while doing so if the item under consideration is expensive beyond your financial means (IPhone 15 Pro Max says Hi!). Again taking an extreme example for clarity – justifying a private jet as must own by saying it saves my valuable time and improves my productivity and buying it on a loan.
Rules of Effective Leverage
I’ve explained the rules in my article, Leverage – A Double Edged Sword. Reproducing them here for quick reference:
Rule#1
(Return on Asset) > (Cost of Loan)
Rule#2
Assets should generate funds before the liability outflow is due.
Rule#1 takes care of profit; Rule#2 takes care of cash flows, and as any successful investor (buyer of assets) will tell you, profits along with positive cash flows are necessary for sustenance of a business model. This duo – profits & cash flows – sets you on a virtuous loop of compounding which shows in due course of time.
If you ensure that you live by these two rules, you’re highly unlikely to face any financial problems ever. On the contrary, this virtuous loop sets you on a path of accelerated wealth generation.
Here’s the Thing
Finding assets which yields more & before a debt, is a lockable and scalable virtuous loop. It sets you on an accelerated path to wealth. All other forms of loans are “less is bad, more is worse” kind and must be avoided.