Debt Can Be An Asset
One of the authors I am working with, Thomas Anderson, has written a new book that is fascinating. He is a nationally recognized wealth strategist who promulgates a powerful approach to debt and personal finances, maps out tax-free retirement income, and reveals a tool that both insulates against financial emergencies and also helps finance luxury items, real estate, and investing. He applies lessons from corporate financing practices and applies them to individuals. His views may seem contrarian, even controversial, but he provides a compelling, alternative and holistic approach to personal finances.
The Value of Debt: How to Manage Both Sides of Your Balance Sheet to Maximize Wealth challenges our basic assumptions and beliefs about the wise and strategic use of debt. It applies the strategic principles of corporate finance to one’s personal wealth and shows us how to manage both sides of the balance sheet. Author Tom Anderson utilizes many of the strategies he employed as an investment banker and as a nationally recognized private wealth advisor with Morgan Stanley. He understands that in order to grow assets – or to protect and preserve them – investors can benefit by embracing debt as a part of their financial portfolio.
Anderson’ book takes a balanced approach to debt. Many individuals either have too much debt, or fall on the other side of the spectrum and are completely debt averse. In the Value of Debt, Anderson makes a compelling argument that there may be a white space in the middle where one can thrive.
The Value of Debt applies ideas that have long been applied in the corporate finance world to the personal balance sheet. He explores what companies do and challenges the reader to consider learning from CFO’s and their approach to finance.
Though the principles espoused in Anderson’s book work best for its intended readership – generally the 7% of the population with investible assets of at least a half-million dollars – many others still acquiring wealth will find it of use as well.
Here is a Q and A with Anderson:
1. Thomas, your book title, The Value of Debt, implies debt might be worth something. How so? We find our self in this world where people tend to either be dramatically over-levered, or they have no debts at all and are completely debt averse. I believe there is a white space in the middle that should be explored, and that we can be adding value within that area in a healthy manner. For example, very few companies have zero debt. In fact, almost every publicly listed company takes on debt of some sort, economists have won Nobel Prizes for models that discuss corporate capital structure, and a primary role for the CFO is to manage both sides of the balance sheet for companies.
2. What are your five tenets of strategic debt philosophy?
· Adopt a Holistic (Comprehensive)—Not Atomistic—Approach
· Explore Thinking and Acting Like a Company
· Understand Limitations on Commonly Held Views of Personal Debt
· Set Your Sites on an Optimal Personal Debt Ratio
· Stay Open-Minded, Ask Questions, and Verify “What Works”
3. How does one limit the risk of being in financial distress This varies greatly on a case to case basis. Some risk factors an advisor cannot directly mitigate. These can include job and income security, if it is a single or dual income household, and the amount of assets the family has saved.
At the same time there are other factors that can be controlled by a qualified holistic advisor. On one side of the balance sheet (assets), this includes overall liquidity, cash reserves, income from investments and proactive positioning for a range of outcomes. On the other side of the balance sheet (liabilities), it includes how much debt the household has, how that debt is structured (how much is amortizing versus interest only / how much has required payments), what lines of credit the family has access to and what happens to those lines in times of distress. An integrated approach to wealth management should make sure that all of these moving pieces are working together to try to minimize both the cost and risk of being in financial distress.
4. How do you take a corporate approach to finance and apply it to one’s personal financial strategy? I transform the concept of a corporate debt ratio into a personal debt ratio. Debt ratios of course vary by company, but most industries exhibit similar trends (on average and within ranges). Accordingly, the book explores the idea that there could be some common ground among individuals that exhibit similar characteristics (again within ranges) that should then be adjusted up and down based on that individual’s unique situation, goals and risk tolerance to form their personal debt ratio.
5. Why do you highly value an Assets-Based Loan facility? Because corporations do; try sending me the list of five large companies that don’t have access to a significant line of credit. Companies focus on having these lines because they enable the company to play better offense and defense. The same applies to individuals. An Assets Based Loan Facility (ABLF) allows individuals and families to play much better offense and defense. With respect to defense: it can be a key source of liquidity in the event of natural disaster or family emergency. Families may be able to better bridge situations and avoid having to liquidate at an in opportune time. From an offense perspective, let's say that I happen to come upon an asset that is trading at a distressed price and I want to be able to buy it instantly: I can wire money from this facility, acquire the asset, and then later make the decision about how I want to pay for it. By having the facility in place, I have a flexible force that can respond in good times and bad times as I choose. I'm not controlled by the market. The bottom line is that an ABLF increases liquidity and should be explored by anyone who does not have one in place.
6. You say we should seek out a holistic financial advisor to guide us. What do they do that is different from other advisors? A holistic financial advisor at a minimum has an investment philosophy, a debt philosophy, and a tax philosophy, among others. All of these beliefs should fit together in to their overall advice and strategy, implementation and review process. In my mind, a holistic advisor should adopt a world-neutral approach to investing, prepare for a vast array of potential outcomes, and understand that the next thirty years may not resemble the financial climate today or of the most recent thirty year period we have experienced. They should have well thought out beliefs with respect to debt and the appropriate levels of debt for an individual to have at different parts in their life. They should understand that the advice they give with respect to investing and debt management - in both the accumulation and distribution phases of a client’s life - may greatly impact that client’s tax bill.
7. How does one generate tax-free income while in retirement? I love the question but there is a lot around this that is hard in a sound bite. I illustrate several ways in the book through a combination of understanding tax facts and implementing some simple strategies that may or may not be appropriate for individuals. Financial advisors are not permitted to give tax advice but they must know tax facts. The real problem in my mind is a lack of understanding of tax facts. For example, many people think that ordinary income is taxed at a rate higher than long term capital gains. That is true sometimes, but many times it is far – very, very far – from the truth. Our tax code has over 4 million words in it. As a taxpayer you should celebrate that! Celebrate AMT! Celebrate complexity! I love our tax code. Generally the more complicated a tax system, the easier it is to build strategies to complement it. Companies clearly do this. Individuals do as well. I’m not sure why more people aren’t talking about this correlation and this issue. For some strange reason our government is talking about building an even more complex system and even higher walls. Although this would be great for business, as a citizen I would be very, very frustrated if some of the current proposals move forward.
8. Why do you oppose the aggressive paying down of debt prior to retirement? I do not entirely oppose paying down debt prior to retirement, but I do feel that it should be done in an informed way. My research shows that most people either have preconceived notions about debt or “guess” about what they should do. It shouldn’t be a “guess.” These are important decisions that merit careful consideration. The benefits and risks of paying down debt (and there are risks to paying down debt) should be compared to the potential benefits and risks of maintaining that debt. It may be helpful to remember that the rate of return on paying down debt is exactly equal to your after tax cost of that debt. With this in mind, if a retirement age couple is under-saved, paying down debt may not be the optimal route to take. In an ironic twist, in some cases paying down debt may actually statistically guarantee they won’t hit their retirement objectives. The book shows there are two ways you may get a 9% rate of return. One is you can look for assets that deliver 9%, the other is look for assets with a 6% expected return and lever them. Both strategies have risks, both have potential benefits. How much debt you have and how it is structured in retirement is likely to be one of the greatest contributing factors to your probability of success and legacy that you pass on. Accordingly, these decisions should be well thought out.
9. What is the optimal debt-ratio one should strive to achieve and maintain? Why? Everybody wants “the number.” More than the specific number, my hope is that people will consider that a number exists based on their circumstances. My sincere hope is that the do not “have their foot only on the brake” or “only on the gas” and will take a more balanced approach. In the book I lay out a range as a starting place for conversations. I challenge people to move that number up and down based on their individual circumstances, goals and risk tolerance. Like most aspects of this book, it depends. I like discussions to start in the 15% and 35% range and adjust it from there. No two people are the same, and everyone will have different reasons for coming up with their own debt ratio. A controversial part of the book is that I propose that this range should stay relatively constant. For most people this implies increasing debt over time, not decreasing it. It may not surprise you to learn that this is exactly what most companies do.
10. What should one consider when planning an investment strategy for 2014? I’m not sure why we focus on the short term so much. If you are concerned about 2014 in particular - and that is the only year you need the money - then I think you should invest in US dollar cash. Most of us are concerned about more than just 2014. Most of us have short, medium and long term goals. I think we should invest according to those goals and measure our investments over the appropriate corresponding time periods. In taking this step it is essential to recognize that I feel that the range of potential outcomes that we could face over the short, medium and long term is vast. Much, much more vast than what we have experienced over the past 30 years. The US, China, Europe, Japan, emerging markets – the whole world – is at a different starting point. When facing a disparate range of outcomes you have to adjust your investment approach. Treat it like sports. Make sure you are playing strong offense. Measure your offense based on appropriate benchmarks. At the same time, make sure you are playing strong defense and don’t measure your defense by how many points they score. There are significant fiscal, monetary and geopolitical risk factors throughout the world. The odds of all of them having a happy ending are low. Start by assuming that whatever you think won’t happen, happens. How are you positioned for shocks during a delicate recovery? You have to be proactive with asset allocation in this environment.
11. What do high-net worth families do to grow their wealth, regardless of market conditions?
Generally there are savers and there are spenders across all levels of income and assets. Most high net worth individuals are savers. Accordingly, they are usually disciplined. They save in good times, they save in bad times. They are prudent. They have a long term horizon. They know that short term losses are inevitable. They know that in a well-diversified portfolio there will always be parts that “look good” and parts that “look bad.” That, in fact, is the expectation of many successful high net worth individual investors I know. They feel that if they aren’t losing money at something then they aren’t trying hard enough and they aren’t diversified enough.
12. You say the next 30 years will not look like the last 30. What are the biggest changes happening now – or that will likely happen – when looking at Wall Street? 50 years ago you could be a doctor. 30 years ago you had to choose to be a radiologist or an orthopedic surgeon. Today that isn’t even specialized enough – I have friends who are specialized in a very specific type of radiology or orthopedics. The same has happened in law. You can’t just be a “lawyer” anymore. Our industry has been slow but it is starting to realize this need for specialization and I think that is the path to the future. There are so many moving parts to the industry that it is hard to encompass all of them. Too many people are a jack of all trades and a master of none.
Commissions have already hit zero. There are excellent sites that provide decent advice at a very low cost. If commissions and general advice are moving to zero, then advisors must specialize. Few advisors have a written investment philosophy. Few have a debt philosophy. Few have studied modern portfolio theory, yet many proclaim to agree or disagree with it. Many do not understand the impact their advice has on taxes. Advisors must master a specific part of the business and be the best in that area. As a result, I think you are going to see a reset in the industry. I think those that figure out a specialization model will win bigger and those that don’t will be left behind.
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Brian Feinblum’s views, opinions, and ideas expressed in this blog are his alone and not that of his employer, the nation’s largest book promoter. You can follow him on Twitter @theprexpert and email him at email@example.com. He feels more important when discussed in the third-person. This is copyrighted by BookMarketingBuzzBlog © 2013
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