Most people fall into debt because they like the appearance of wealth. Things like clothing, vacations, nice cars, gadgets, and similar trinkets are worth taking on the debt to create an illusion of wealth. Many Americans have a closet full of clothes, a house full of unnecessary gadgets, and they've traveled all over the place. A large majority overspend and over-consume. Many of us can't afford to do this, so we
get into trouble with it. We let ourselves
be overcome with destructive debt, when we should instead have constructive debt.
Constructive VS Destructive Debt
When evaluating constructive debt vs destructive debt, keep these two things in mind:
- Constructive debt = Investment debt.
- Destructive debt = Consumer debt.
So what is the difference between investment
debt and consumer debt? Investment debt is any kind of debt accrued by loaning money to an entity, in this case diversified income properties, for a defined period of time at a fixed interest rate. Jason Hartman recommends 30-year mortgage loans with fixed interest. This is good debt.
Consumer debt is any kind of debt accrued from the purchase of consumable goods which do not appreciate in value. This kind of debt typically isn't beneficial, and if not managed correctly, can frequently lead to bankrupt
cy. Income property appreciates in value, and therefore is not defined as consumer debt.
Investment debt is constructive debt, and can therefore be classified as good debt. Our banking system and the IRS will reward us for being in debt, as long as it's the right kind of debt. They'll provide us with loan modifications and short sales, and they'll allow us to deduct interest.
How Much Money Do We Need in Reserves?
To determine how much cash to hold in reserve, look at the value of your portfolio. 4% of that number should be enough, at a minimum. That will cover vacancies and any other unforeseen problems. So, if there's $500,000 worth of property in your portfolio, $20,000 of it should be in reserves. If your portfolio is worth $1 million, have $40,000 in the bank to cover any unforeseen circumstances.
Overall, never be in a position where you have to sell. Use reserves to prevent this from happening, and don't get into trouble. Don't lose money. What else can you do to avoid potential problems? Follow Jason Hartman's 10 Commandments of Successful Investing. Don't speculate, and only acquire properties that make financial sense the day you buy them. (Top Image: Flickr | Images of Money)
The Young Wealth Team