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 brianfeinblum@gmail.com. He feels more important when
discussed in the third-person. This is copyrighted by BookMarketingBuzzBlog ©
2013
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