Written by Robert Kiyosaki Read time: 5 minLast updated: March 17, 202011.1K

How to leverage and use good debt to create wealth

Many people teach that debt is bad or evil. They preach that it is smart to pay off your debt and to stay out of debt. And to an extent they are right.

There is good debt and bad debt. It is wise to pay off bad debt—or not get into it in the first place. Simply said, bad debt takes money out of your pocket, and good debt puts money into your pocket.

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A credit card is often bad debt because people use it to buy depreciating items like big screen TVs, cars, and vacations. Conversely, a loan for an investment property that you rent out can be good debt if the asset’s cash flow covers the debt payment and puts money in your pocket.

The people who preach the evils of debt do not understand that debt is essential to the American economy. Whether that is good or bad is debatable, but what is not debatable is that without debt, our entire economy would collapse. Our entire economy is based on steady inflation. And the way in which we encourage that inflation is through debt.

Unfortunately, the way the rich use debt and the way the poor and middle classes use debt are vastly different.

How the poor use debt

As mentioned above, the poor and middle class use debt to generally buy liabilities like a car or a vacation. Here are some examples of how poor people use debt:

Bad debt #1: High-interest credit cards

Bankrate.com reports that average credit card interest rates are in the low 17% range. Beyond that, credit cards often have hidden rates that can cost you hundreds of dollars for things like late fees, annual fees, and currency exchange rates.

Credit cards are neither good or bad in and of themselves. It’s how you use them. Unfortunately, the poor often use credit cards in the worst way by buying liabilities like televisions and vacations, only to pay the minimum payment each month. By doing this they pay substantial amounts of interest over long periods of time for goods that lose value. It’s a double whammy.

Bad debt #2: Loans for liabilities

There are lots of loans out there that you can get for liabilities. From car loans to personal loans to payday loans, you can find a way to take on more debt…often at a high price.

They also pull out loans for things they consider to be investments, such as their own personal home. But a house is not an asset. Why? Because the very simple definition of an asset is that it puts money into your pocket. A liability takes money out. A personal home only takes money out of your pocket. This is not to say that you shouldn’t get a mortgage, but don’t do it thinking you’re buying an asset…and especially don’t take on way more than you can afford thinking it’s a good investment.

This method of using bad debt to attain things that generally lose value over time keeps most people financially enslaved to debt for most of their lives. And when they do finally decide to get off the drug of bad debt, they often spend years working harder and harder to pay it off. It’s a lot of lost time and opportunity.

How to use good debt like the rich

The rich use good debt to grow their worth, and they invest in cash flowing assets using Other People’s Money (OPM)—both the bank’s and investors’.

OPM is a fundamental concept of Rich Dad and a sign of high financial intelligence. By using both good debt and OPM, you can dramatically increase your Return on Investment (ROI)—and you can even achieve infinite returns.

Good debt is a type of OPM. The downside to debt is that you can generally only borrow a certain percentage of an asset’s purchase price. In keeping with our real estate example from my previous post on good debt, that is generally around 70 to 80 percent of the purchase price.

Because of this, you have two choices when you find a worthy investment: use your own money or use other people’s money. Provided you structure the deal well, the more you can use other people’s money, the higher your return will be.

Many people think it’s a fantasy world that people would just give you money to invest, but that couldn’t be further from the truth. The reality is that most people don’t have time to find good deals. Instead, they rely on people with the proper financial education, skill set, and drive to bring deals to them.

My real estate advisor, Ken McElroy, has perfected using OPM. His company, MC Companies, buys apartment buildings. He does all the hard work of finding deals, doing the due diligence, negotiating with owners and lenders, and handling management. In return, people line up hoping to invest their money with him.

Today, Ken does big deals that require a certain type of investor. Not just anyone can invest with Ken. But he started with small deals, like the ones I’m writing about today and worked his way up to big deals.

How to use debt to buy real estate and create wealth

Here’s an example from real estate on how the rich use good debt as money to create wealth.

Using the bank to leverage my investments, I can leverage my money. Using simple math, let’s assume I have $100,000 and am looking to invest it in a $100,000 property that rents for around $800 per month. You can find many properties like this if you look diligently.

I could use all my money to purchase one property for $100,000, or I could use good debt to buy five $100,000 properties.

The bank would lend me $80,000 for each property and I would divide my $100,000 into five $20,000 down payments.

At 5 percent interest, the payment on the loans would be around $500, including taxes and insurance. So, my cash flow on each property would be $300 a month ($800 in rent – $500 in debt payment = $300 per month) for a total of $1,500 ($300 x 5 = $1,500) per month—an 18 percent annual return.

How to use debt even more to your advantage with OPM

Now, here’s an example of why using good debt, coupled with OPM, is an even more powerful investment tool for the rich.

Using OPM, I can increase my return and secure even more assets. Let’s say that instead of having to put down 20 percent on five properties, I can use my $100,000 to put down 5 percent on 20 properties. I can do this by finding 20 great deals and lining up investors to invest in them.

Here’s how the math works out.

The bank would lend $80,000 for each property, and I would divide my $100,000 into twenty $5,000 segments, using OPM to raise the other $15,000 needed for each property. Again, at 5 percent interest, the payment on the loans would be around $500 per month. Let’s assume that we’ll pay a little more for our investors’ money and give them 7 percent interest. The money owed to them would be a little less than $100 per month—but we’ll go with $100 to make it simple. So, our total costs would be about $600 per month.

That means we’ll have a cash flow of about $200 per month, which we’ll split with our investors 50/50. We’ll pocket $100 per month, or $1,200 per year, and our investors will pocket $100 per month, or $1,200 per year.

Adding up the total return for all 20 deals, that’s $24,000 per year cash flow, a return of 24 percent. Not only am I making 6 percent more per year than if I just used my money, but I also have ownership in 20 assets instead of just 5. Later I can refinance these properties, pay off my investors, get my investment back, and continue to receive cash flow from the 20 properties—an infinite return.

Again, I’m using very simple math here. In real life, the numbers are more complicated and much larger. But the principles are the same. Investing with OPM takes a high level of financial intelligence. But both Ken McElroy and I both started small and worked into the big apartment deals we do today. You can do the same.

Be diligent. Continue to increase your financial education. Work hard. And master the fundamentals of good debt and OPM, and you will become wealthy

Warren Buffett

Buffett was born in 1930 in Omaha, Nebraska, of distant French Huguenot descent. He was the second of three children and the only son of Leila (née Stahl) and Congressman Howard Buffett, Buffett began his education at Rose Hill Elementary School. In 1942, his father was elected to the first of four terms in the United States Congress, and after moving with his family to Washington, D.C., Warren finished elementary school, attended Alice Deal Junior High School and graduated from Woodrow Wilson High School in 1947, where his senior yearbook picture reads: “likes math; a future stockbroker.”

Buffett displayed an interest in business and investing at a young age. One of his first business ventures, Buffett sold chewing gum, Coca-Cola bottles, or weekly magazines door to door. He worked in his grandfather’s grocery store. While still in high school, he made money delivering newspapers, selling golf balls and stamps, and detailing cars, among other means. On his first income tax return in 1944, Buffett took a $35 deduction for the use of his bicycle and watch on his paper route. In 1945, as a high school sophomore, Buffett and a friend spent $25 to purchase a used pinball machine, which they placed in the local barber shop. Within months, they owned several machines in 3 different barber shops across Omaha. The business was sold later in the year for $1,200 to a war veteran.

Buffett’s interest in the stock market and investing dated to schoolboy days he spent in the customers’ lounge of a regional stock brokerage near his father’s own brokerage office. On a trip to New York City at age ten, he made a point to visit the New York Stock Exchange. At 11, he bought three shares of Cities Service Preferred for himself, and three for his sister Doris Buffett (founder of The Sunshine Lady Foundation). At the age of 15, Warren made more than $175 monthly delivering Washington Post newspapers. In high school, he invested in a business owned by his father and bought a 40-acre farm worked by a tenant farmer. He bought the land when he was 14 years old with $1,200 of his savings. By the time he finished college, Buffett had accumulated a princely sum of more than $90,000 in savings measured in 2009 dollars.

In 1947, Buffett entered the Wharton School of the University of Pennsylvania. He would have preferred to focus on his business ventures; however, he enrolled due to pressure from his father.  Warren studied there for two years and joined the Alpha Sigma Phi fraternity. He then transferred to the University of Nebraska–Lincoln where at nineteen, he graduated with a Bachelor of Science in Business Administration. After being rejected by Harvard Business School, Buffett enrolled at Columbia Business School upon learning that Benjamin Graham taught there. He earned a Master of Science in Economics from Columbia in 1951. Buffett also attended the New York Institute of Finance.

The basic ideas of investing are to look at stocks as business, use the market’s fluctuations to your advantage, and seek a margin of safety. That’s what Ben Graham taught us. 

By 1950, at 20, Buffett had made and saved $9,800 (over $96,000 inflation adjusted for the 2014 USD). In April 1952, Buffett discovered that Graham was on the board of GEICO insurance. Taking a train to Washington, D.C. on a Saturday, he knocked on the door of GEICO’s headquarters until a janitor admitted him. There he met Lorer Davidson, Geico’s Vice President, and the two discussed the insurance business for hours. Davidson would eventually become Buffett’s lifelong friend and a lasting influence, and would later recall that he found Buffett to be an “extraordinary man” after only fifteen minutes. Buffett wanted to work on Wall Street; however, both his father and Ben Graham urged him not to. He offered to work for Graham for free, but Graham refused.

Buffett returned to Omaha and worked as a stockbroker while taking a Dale Carnegie public speaking course. Using what he learned, he felt confident enough to teach an “Investment Principles” night class at University of Nebraska-Omaha. The average age of his students was more than twice his own. During this time he also purchased a Sinclair Texaco gas station as a side investment. However, this was not successful.

In 1952, Buffett married Susan Thompson at Dundee Presbyterian Church. The next year they had their first child, Susan Alice. In 1954, Buffett accepted a job at Benjamin Graham‘s partnership. His starting salary was $12,000 a year (approximately $105,000 inflation adjusted for the 2012 USD). There he worked closely with Walter Schloss. Graham was a tough boss. He was adamant that stocks provide a wide margin of safety after weighting the trade-off between their price and their intrinsic value. The argument made sense to Buffett but he questioned whether the criteria were too stringent and caused the company to miss out on big winners that had other appealing features. That same year the Buffetts had their second child, Howard Graham. In 1956, Benjamin Graham retired and closed his partnership. At this time Buffett’s personal savings were over $174,000 ($1.47 million 2012 USD) and he started Buffett Partnership Ltd..

In 1957, Buffett operated three partnerships. He purchased a five-bedroom stucco house in Omaha, where he still lives, for $31,500.

— Warren Buffett

The Myth of Treating People Fairly and EquallyBy Jeff Mowatt

I’ll just come right-out and say it. I believe that treating customers fairly and equally is a mistake. It’s unprofitable. It belittles customers and employees. And it’s unethical. There, I’ve said it.
Certainly, we should treat people fairly – but not equally. I’m not advocating some Orwellian decree that ‘some animals are more equal than others’. This has nothing to do with a customer’s value as a person. It has to do with bending so-called ‘rules’ to give exceptional customers the kind of unique service they deserve.
In my many years working as a consultant and trainer with dozens of companies and bureaucracies, it’s unfortunate that I continue to encounter employees who buy-in to the myth of the virtue of treating all customers equally. If this is the case in your organization, consider this scenario…
Imagine that as part of your daily routine, you stop into your local convenience store to buy a coffee and newspaper. The store employees know you by sight. One day you find yourself needing to change a $100 bill. You stop in, pick up a couple of items and pay for them with the hundred. The store has a policy that they don’t accept hundreds, so the cashier simply refuses you. You are fully aware that they make more than that much change every 15 minutes. You also know that when added-up, you’ve given them hundreds if not thousands of dollars worth of business over the years. Yet they refuse to grant you this slight favor. How’s your customer loyalty now?
Refusing your $100 bill would have been an incredibly bad decision on the part of the cashier as well as the management who created the ‘rule’ that permits no exceptions for the store’s best customers. The problem is that by definition a ‘rule’ treats everyone equally – whether it’s fair or not.
What if we treated our children this way?
Imagine the consequences of a parent treating their six-year-old and seventeen-year-old equally. That would mean telling the younger child, “Make sure you are home from grade one by midnight!” Most people appreciate that it makes sense to treat children fairly. It would, however, be a mistake to treat them all equally, and apply the same rules regardless of their ages. That’s more than just a mistake; we might even call it immoral.
We already discriminate in the workplace
There’s a certain irony to taking this approach to the workplace. The same individuals who assume that all customers should be treated equally, often have no objection whatsoever to the organization offering preferential parking and restroom facilities to customers with disabilities. Yet, that’s a blatant example of treating customers fairly but not equally. I don’t know of anyone who objects to organizations giving better parking spots to the disabled. Yet, every day we hear employees using inane statements like, “If I did that for you, I’d have to do it for everyone.” The challenge for business owners and managers is providing the kind of training and authority that front-line employees need, so that they will make more appropriate on-the-spot decisions for customers.
The truth about word-of-mouth
“What happens when customers talk to each other?” That’s one of the most common concerns I hear from employees in my training sessions where we address this subject. They are afraid that if they accommodate one customer’s special request, then that customer will talk to other customers, and the employee will be pressured to do the same for everyone, which, of course, they can’t do. In other words, they’re going to have a lot of unhappy people out there if they accommodate special requests. This is the kind of convoluted logic that stems from the underlying belief in treating everyone equally (not necessarily fairly). Another way of putting it is: I’m afraid that if I provide an extra service for one customer (because we made an error or the customer does a lot of business with us), then I’m going to disappoint other customers whose circumstances don’t warrant the extra service. So to avoid disappointing some people, we’ll just make a rule that no one gets special treatment. That way, we’ll just disappoint everyone, including customers whose unique situation deserves extra service.
Customers understand the concept of fairness. If I’ve never been to a particular convenience store and suddenly walk in just to change a hundred-dollar bill, I’m not likely to get outraged when the employee explains that they don’t have enough change on hand so they can’t help me. If, on the other hand, I’m doing business there every day, I’m more likely to be upset ifmy store won’t make change for me when I know they make that much change every fifteen minutes. If they do make an exception for me because I’m a good customer, I’m not going to rush out, phone all my friends, and tell them, “Hey, my convenience store made change for me, and they don’t usually accept hundreds!” Customers rarely go out of their way to talk about good service. The occasion when customers share information about a business is when the service is bad. Bottom line: employees needn’t worry about possible negative ramifications of taking extra care of good customers. What they should be far more concerned about is the negative impact of treating all customers the same.