Looking For Perspectives On Using Debt As Income vs Paying Yourself An Income

[tonyf7]

I've been hearing a lot lately about how the rich don't pay themselves an income, but instead borrow against their assets and use that debt to finance their lifestyles. So long as their assets continue appreciating in value, they can continue borrowing against them and avoiding a huge tax burden.

It makes sense to me for tax mitigation purposes, but getting into debt and hoping that your assets continue growing in value seems like a gamble to me.

Is this "debt as income" narrative a financially sound strategy?

What would @MJ DeMarco do? (WWMJD)

I understand how letting money sit in a bank is a guaranteed loss due to inflation, but going to the other extreme (debt) seems sort of risky to me.

Is there a better way? Or is using debt "the" way?

From what I can tell by reading all of MJ's books, it seems like he advocates having little to no debt and having an FU sum of money invested and earning you a healthy income. I don't recall ever reading anything about using debt in the way I've described above.

Thoughts?

 

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[Mikkel]

I don't know "WWMJD" but in regard to inflation and debt. It is generally thought to be good to have debt when inflation is high.

Example: 10% inflation rate + 5% intrest rates would equal -5% real rate which mean 5% of the debt gets devalued each year.

In regards to if you should take on debt just to have income. Seems risky, but I'd be intrested to see what people say.

 

[Jobless]

Got millions or billions locked in illiquid assets?

Since actual inflation (money printing leading to increase in money supply, not CPI) has averaged more than 7% annually for the last 20 or 30 years, any loan with fixed interest rate below 7% makes sense. Depending on what your assets are, your place in the economy is dictated, putting you close or far away from the money printer. If far away, you cannot access beneficial loans, and the value of your cash and assets are eroded through different types of taxation, including inflation. This forces you to work or take on risk, just to keep what you already own.

Debt is debt, not income. However, if you borrow newly printed money you essentially receive a state grant, not debt. The money did not exist prior to the loan, so who did you borrow it from? Officially, you borrowed it from a bank, which borrowed it from the central bank. But who did they borrow it from? They created it through digital money-printing, which is a tax on everyone who holds the currency (inflation).

The central bank cannot create wealth, only transfer it. Because of this, interest rates are bogus, and as arbitrary as inflation rates. This creates an unstable economy with cycles, where interest rates shift constantly. However, it is possible under these conditions to accumulate assets if you control the system, and to a lesser extent if only you understand how it works.

The loan can be spent on more assets, to lobby politicians, and to pay your living expenses. In theory, you will also create more jobs, increase production and consumption of goods, and thus this is justified according to the proponents of this system.

 

[addV]

You could just use the cashflow that those assets generate as well, not sure I fully get the use case of when you want to do that,

Anyway, that's probably an option only available when you have got a net worth of 8+ figures, are you already there?, or why even worry now? It does not sound like something you need to plan in advance

 

[tonyf7]

You could just use the cashflow that those assets generate as well, not sure I fully get the use case of when you want to do that,

Anyway, that's probably an option only available when you have got a net worth of 8+ figures, are you already there?, or why even worry now? It does not sound like something you need to plan in advance

I currently own a business and I'm considering purchasing some equipment that should generate more income. As I did research, I kept coming across this idea of buying assets and borrowing against them, which led me to ask the question that I posted.

 

[Kevin88660]

I've been hearing a lot lately about how the rich don't pay themselves an income, but instead borrow against their assets and use that debt to finance their lifestyles. So long as their assets continue appreciating in value, they can continue borrowing against them and avoiding a huge tax burden.

It makes sense to me for tax mitigation purposes, but getting into debt and hoping that your assets continue growing in value seems like a gamble to me.

Is this "debt as income" narrative a financially sound strategy?

What would @MJ DeMarco do? (WWMJD)

I understand how letting money sit in a bank is a guaranteed loss due to inflation, but going to the other extreme (debt) seems sort of risky to me.

Is there a better way? Or is using debt "the" way?

From what I can tell by reading all of MJ's books, it seems like he advocates having little to no debt and having an FU sum of money invested and earning you a healthy income. I don't recall ever reading anything about using debt in the way I've described above.

Thoughts?

With the exception of real estate developers who do actively use debt, the idea of rich using debt to finance their business is largely a myth.

For people who do not bootstrap their business it is largely done through equity financing. Asking people to invest in their business. A lot less risk.

If you need to refinance your home to start a business you probably are taking too much financial risk.

There are super rich CEO who use borrowing against their own holding of company shares to finance their lifestyle. Its due to an unique circumstances that their compensation in cash is not high, and liquidating too much stocks within a short period of time will lead to investors to question their own stake in the game. There are also tax considerations.

If you own a mid size company with a decade long track record of good cashflow you could borrow from a bank under the company’s name to improve your company’s cashflow but I would say this does not apply to most small players in the game whose only mean of borrowing is to increase their personal liability.

 

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[tonyf7]

If you own a mid size company with a decade long track record of good cashflow you could borrow from a bank under the company’s name to improve your company’s cashflow but I would say this does not apply to most small players in the game whose only mean of borrowing is to increase their personal liability.

Good insight, thank you. I've owned my service-based business for a decade now, and my tax bill last year was horrific, but also a good sign that I'm profitable. I would rather not do that again, though. So that's why I'm looking to purchase some income-generating assets instead.

In hindsight, it was a good move to pay taxes all of these years instead of writing off every possible "expense" that I could find in order to avoid taxes. Because now, the bank is more than willing to throw money at me because my tax returns show profit.

 

[biophase]

Good insight, thank you. I've owned my service-based business for a decade now, and my tax bill last year was horrific, but also a good sign that I'm profitable. I would rather not do that again, though. So that's why I'm looking to purchase some income-generating assets instead.

In hindsight, it was a good move to pay taxes all of these years instead of writing off every possible "expense" that I could find in order to avoid taxes. Because now, the bank is more than willing to throw money at me because my tax returns show profit.

I feel like this is more like, you own a property you paid $100k for and now it's worth $1M. If you sell it, you pay taxes on $900k. So instead you borrow $500k against it and now you have $500k in the bank account. So it's like you got $500k "income". Of course you are paying interest on the $500k as you spend it.

Let's say you borrowed the $500k at 5%. So you are paying $25k a year to use it. In 5 years, you've paid $125k in interest and spent the $375k of "income".

You did not pay any taxes on this $375k of "income", but you did pay $125k in interest. But this is still way better than selling your asset for $1M, and paying $180k in taxes (20% cap gains) and collecting $620k. Because in 5 years your asset could be worth $1.2M now and it's probably still generating cashflow.

So if you just look at the 2 scenarios 5 years later:
1) Sell for $1M, pocket $680k, pay $180k taxes, spend $375k. You have $305k left in the bank.
2) Borrow $500k, pay $125k interest, spend $375k. You have $500k equity in your asset, and it might have increased in value, and it might have produced cashflow.

 

[Two Dog]

With the exception of real estate developers who do actively use debt, the idea of rich using debt to finance their business is largely a myth.

Yep, true in my world.

I've been hearing a lot lately about how the rich don't pay themselves an income, but instead borrow against their assets and use that debt to finance their lifestyles.

Not meaning to sound sarcastic (it's not), but who are you hearing this from?? Are you hearing it from wealthy people??

I know personally or have worked with several dozen self-made people with 7 and 8 figure net worths. Their wealth came primarily from real estate and selling/investing in tech companies. Outside of real estate - like @Kevin88660 mentioned - it's been my experience that none of them would leverage against investment assets. They would certainly never borrow money to pay for some personal doodad. You just buy it with cash.

Think of it this way. They have already won the game and realize it. Taking on debt is inherently risky because it involves things that aren't under your direct control. Everyone who's wealthy enough for long enough knows that Rule #1 for staying wealthy is taking your chips off the table and moving into more conservative investments especially as you get older. Everyone knows a few people who didn't step back, got a bad roll of the dice and are back in the land of earning money to pay the bills. No one wants to end up back there.

 

[MJ DeMarco]

Is this "debt as income" narrative a financially sound strategy?

No, it sounds ridiculous.