Good Debt, Bad Debt

Robert Kiyosaki, author of the best-selling personal finance book “Rich Dad, Poor Dad”, had successfully identified the difference between an asset and a liability. He also genuinely dismissed the idea that all debts are bad and even went on to say that the rich have huge debts! 

But what sets apart the rich from the poor if both carry debts anyway? 

It is the type of debt that they have.

Good Debt is when you borrow money to buy an asset -- something that will put money in your pocket.

Bad Debt is when you borrow money to further increase your liabilities -- things that take out money from your pocket.

How could you get into bad debt?

It's when you fail to tell the difference between an asset and a liability. So instead of buying a tricycle to generate an income for the family, you buy a single motorcycle for pogi points. It won't bring money in to your pocket, yet will take out money from it every time you gas up, tune up and pick up someone (of course you'll go into a date, right?).

But not because you invested some borrowed money means it is already considered a good debt. Let's say you borrowed money and decided to put it on a bank or to invest it in a mutual fund or stock market.

When you put your money in the bank on a regular savings account, you're making a really bad decision. Why? Because your money will earn measly 1% per year yet the interest rate on your loan will charge you on a monthly basis!

The same holds true when you invest borrowed money on mutual funds or stock market. Yes, the returns may be superior to the interest charge, but what about the market volatility? Remember that these types of investments are not guaranteed to give you immediate returns since they are best held long-term. Hence, you might end up paying the interest charge of the money you borrowed while seeing the value of your investments go down (if the market goes down). But this is OK, provided that you have enough funds to cover other expenses such as emergencies so that you won't have to withdraw your investments even when the market is down.

Likewise, many people borrow money to purchase a gadget, thinking that a gadget is a valid “investment”. A gadget is not an asset. Not when its value get depreciated over time. Remember that a gadget loses its original price from about 10 to 30% the moment you take it out of its box! But if you use a gadget to your advantage, then it becomes a good debt. One good example is when you loan a professional camera out of your hobby of taking pictures. When you develop such hobby that it becomes your profession, be it a sideline or full-time, the borrowed money you put for the camera can be considered a valid investment and thus, a good debt.

If you borrowed money from some of your friends in order to by a guitar, is it good debt or bad debt?

Think.

The purpose of the guitar will answer the question. 

If you use the guitar to beat boredom at night before you sleep, you've got yourself not just a bad debt but a bad neighbor to throw something in your roof as well! (Not unless you're a good singer.) Now if you use the guitar to serenade a woman you're courting, good luck! I hope she says “Yes!” after, because pick-up lines works better now, trust me.  But if you consider that woman to be an investment (meaning someone who'll pay for your tuition, bills, etc. when she falls for you) then what a good debt you just had! Just kidding!

Seriously, determining whether a debt is good or bad will depend on your ability to identify if your purpose will increase your assets or liabilities.

	Did you learn the difference between good debt and bad debt? Receive FREE updates on great articles like this when you subscribe to PisoandBeyond!