"Borrowing to finance an investment that makes money is one way to make debt work for you. For instance, if you borrow to buy a property which has a positive cash flow the result can be very handsome profits. Keep in mind, though, that this enhanced profit is a result of the leverage resulting from the debt and the leverage works both ways. The same leverage that produces handsome profits can result in devastating losses if your assumptions turn out to be wrong."
The column went on to give a real estate example that illustrated the issue and some advice on how to avoid problems. At the time, the advice seemed almost archaic. Today it seems a bit more prescient, although I'll admit I was thinking on a personal scale rather than the macro scale so obviously applicable today. Even so, for those who are struggling to understand the markets today or a related pressure cooker, a review of those Feb 2007 posts might be worthwhile.
If you are considering debt, give the following some consideration:
- What is the worst that can happen?
- Can I afford the debt if the worst case develops?
- Are the benefits worth the risk?
If the risks are seriously evaluated and considered, most debt will not be undertaken.
If you are already in the pressure cooker:
- Accept the reality of your situation. Denial is generally the biggest barrier to recovery.
- Sell off assets to reduce debt.
- Reduce living costs to that required to clear debt in a reasonable time frame.
- For details and support, I'd recommend some time spent listening to Dave Ramsey on TV or radio.
Amazingly, the above advice seems eerily applicable to the CEOs of many financial companies making the news these days. If you are watching the stocks of those companies, be aware the damage has been done. It is too late to unload them. The good news is that, as with individuals, if they can work through the issues, life can be good on the other side.