Sunday, November 10, 2024

Other People’s Money (OPM): How to use debt strategically to your advantage

Most of us would like to fund our lifestyle and financial goals without having to worry about money being enough to cover expenses. We work hard to attain financial security. However, financial security requires commitment, discipline and the right knowledge, or what I call financial intelligence. 

One way to be financially smart in your journey to attain financial security is to know how to use other people’s money (OPM) to your advantage. The phrase, “other people’s money” can be traced back to Adam Smith’s book titled The Wealth of Nations (1776), where he was of the view that corporate directors tend to be inefficient as they care for “other people’s money”. In this case, other people referred to the shareholders. They stand to gain or lose with right or wrong decisions made by the directors. Corporate Governance came to the rescue to address possible inefficiencies. 

In that regard, equity or selling shares is a way that you can use OPM. Another form of OPM that I would emphasise in this article, is the use of debt or financial leverage to acquire assets or build a business. Contrary to the belief that debt is bad, the rich have been using debt to get richer. Interestingly, banks are the master of this strategy. 

The bank uses OPM to make more money. To the bank your savings deposits represent OPM. Deposits are a liability or an expense to the bank and in that regard they pay interest on them, however low. The bank in turn uses your hard-earned savings to make more money by lending it to borrowers at a higher interest rate or buying interest-earning securities such as bonds, certificate of deposits, etc. To the bank, loans are assets and they are often the bank’s major source of revenue. Commercial banks, therefore, model how OPM can be used to build wealth. They use debt to their advantage. 

It is time to think like a bank. The key is to understand the difference between good and bad debt. Good debt simply puts money in your pocket. In other words, it increases your cash flow. An example would be buying an investment property with debt. This is the kind of property that will cover your cost of borrowing. In this case, it gives you rental income which is more than your monthly mortgage payments. Another good example is starting or expanding your business. 

On the other side of the coin, bad debt takes more from your pocket. It is a similar concept used in accounting which refers to accounts receivable that would not be collected. It is a loss to the business. Bad debt is mostly taken to maintain lifestyle. Unfortunately, this is what has kept most people trapped in debt. An example of bad debt would be a car loan because it is used to buy a depreciating asset. A new car depreciates in value even faster than a used car. Another common example of bad debt is a personal loan taken to support living expenses.

With the just recent cut of the bank rate, it would be wiser to understand this concept. On 8 October 2020, the bank rate was slashed by 50 basis points from 4.25 percent to 3.75 percent, making borrowing even more attractive. In an accommodative monetary policy environment such as this, using debt strategically will without a doubt work on anyone’s favour. However, all it takes is financial intelligence. 

Remember to think like a bank, make financial decisions like the rich and financial security will be certain. 

Disclaimer: Otisitswe K. Tawana-Madziba is the founder of Fin-Edu. For comments kindly send an email to [email protected] or visit www.fin-edubw.com

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