I was asked an interesting question this week by a client looking to leverage an investment in the stock market. He asked me, "What's the most effective level debt that I need?"
Before I answer that question, let me clarify; there are two types of debt. Good debt and bad debt.
Bad debt is unproductive, it doesn't create wealth. Bad debt is used to buy assets that depreciate and lose value. This includes credit card debt, personal loans, car loans and those "interest free" store finance leases.
Good debt is leverage used to acquire assets that generate income and appreciate in value. Assets like real estate, stock and business. As such this would include debt like home loans, margin loans, derivatives and business loans.
So to answer the question, how much debt? The answer, disappointing as it is, is there is no right answer.
To find out how much leverage is right for you, you need to weigh up the risks versus the benefits and figure what your risk tolerance is. But ultimately you need to apply what I call the sleep test. The sleep test is: How much debt can you take up before it starts keeping you up at night?
If your debt is keeping you up at night, chances are it's too much and it's probably not worth the lost ZZZs.
Food for thought,
Chris Hooper
(Innovate or Die)