Why do billionaires have so much debt? There’s one question that haunts every person who dreams of making it big in business, and the answer may surprise you!
A new study sheds light on the reasons behind this phenomenon, providing valuable insight into the world of finance and business startups.
The science of having no choice
Our results suggest that rich people may be no different from everyone else: We’re all just doing what we can to make more money, and sometimes we end up taking out a loan to do it. But when someone has more assets, they might actually have less choice in whether they take on debt: The opportunity cost of not using that asset may be too high, even if it means going into debt.
Of course, taking out loans is nothing like having no choice at all, and rich people are obviously still free to spend their money how they want to. But it does mean that simply writing off a tendency toward debt as bad character or oversight is wrong—it’s in fact a pretty rational decision, given what most people with great wealth already have: assets that are often hard to cash out without losing big chunks of them in fees and taxes. Debt may not be ideal for anyone, but if you’re rich and you need more income, it could make a lot of sense to put some of your wealth up as collateral for a loan.
If you think about it, spending cash makes a lot less sense for a rich person than for someone with more limited resources: If your income is in cash, and you spend it all, then you’re left with nothing to invest or pay off debts with later. Going into debt may make sense if there’s something big coming up—like an opportunity to expand your business that you can use to pay back your loan in full—but in general, taking out loans doesn’t mean that rich people don’t care about their money as much as everyone else does. It just means they can afford to take bigger risks when they want to get richer still.
How to think about your wealth
Wealth is not just cash in your bank account—that’s a limited view of personal and financial freedom, according to New York Times best-selling author David Bach. Instead, wealth is having enough passive income coming in every month that you never need to work for money again if you don’t want to, he says. In other words, your wealth is actually your income minus all of your expenses (and debts). Why does it matter how you think about your wealth? When it comes to getting rich and staying rich, it can make all the difference in whether or not you will ever be able to save and retire early — an ultimate goal that most people still dream about achieving someday.
If you’re still working to earn your income and are in debt, getting out of that situation could be a good way to get closer to your ultimate goal of financial freedom. How can you increase your wealth today? What I tell people is start with just setting up a savings account, and putting whatever money they can spare into it every single month, Bach says. Even if you only manage to put away $50 a month at first, he recommends sticking with it because it shows discipline and helps you break your spending habits by building an automatic deposit into your checking account. If you’re able to save more — like $100 or even $200 a month — then go for it, he says. It all adds up!
What to watch out for in the future
The picture is mixed. Some studies suggest it’s smart to carry a fair amount of debt early in your career, when you’re taking risks and learning from mistakes, as long as you’re also careful about how much you borrow and what kind of interest rate you’re paying on that money. But that strategy doesn’t work for everyone: New research out of Wharton shows that risk-taking is actually more common among people who grew up with more, not less—and these individuals are also less likely to get into financial trouble by their 30s.
The authors didn’t set out to find if rich people are more or less financially literate than poor people. Rather, they wanted to learn more about how growing up with the money—or a lack of it—can shape risky financial behaviour as adults. To test their hypothesis, they developed two surveys: one that asked their subjects about their income and wealth, and another that asked them about their spending habits, attitudes toward risk and other questions designed to assess whether they were financially literate. For example, they presented people with a series of hypothetical but realistic scenarios involving credit cards and cash loans and then asked how likely respondents would be to make different types of purchases in those situations or choose certain repayment plans.
The results, published in Psychological Science, a journal of the Association for Psychological Science, showed that people who grew up with more wealth were more likely to take financial risks in adulthood. What’s more, their attitudes toward risk were largely shaped by their childhood experience; it wasn’t just a reflection of what they thought was appropriate when they were adults. For example, respondents who grew up rich but then lost most of their money during a recession—and took out loans to get by—were still far more comfortable with risk than respondents who lost all that money as kids but went on to become wealthy later in life through their own accomplishments or lucky breaks.
When is debt bad? And when is it good?
Borrowing money seems to be taboo for many people and society as a whole, but why is that? Why can’t we accept that borrowing money can actually be a good thing? The truth is, taking out loans doesn’t always work against you; sometimes it’s worth it in order to build wealth faster than you would have otherwise. The key is knowing when to borrow and when not to, as well as knowing how to choose between different types of loans (like a personal loan versus a business loan). Knowing what works for you specifically will take some time and research, but in time you’ll know exactly when it’s appropriate for you to take out debt — or if it even makes sense at all.
If you’re struggling to find a job, for example, then taking out a loan may be an appropriate way to build your business, start a business or pay for an education that could lead to greater financial success. But if you’ve got a steady job but are lacking in savings and investments, then it may not make sense for you to take out debt at all — instead, you should focus on building up your savings and putting money away into investments. As always with money matters, there’s no single right answer; different approaches work well for different people depending on their unique situations and goals.
The good news is that there are a lot of options available to help you find and use credit wisely; one popular option is a personal loan, which can be used for almost anything from paying off bills to buying real estate or even starting your own business. It’s also possible to get loans for almost any purpose through peer-to-peer lending networks like Lending Club, Kiva and Prosper. When looking into these types of loans — as well as other common sources of loans — it’s important to look into interest rates, since lower interest rates usually mean better deals, while higher rates may indicate more risk or hidden fees.
How the rich use debt to get richer
While it may seem odd to think of rich people taking out loans to expand their wealth, that’s exactly what many of them do. It turns out there are numerous advantages for both parties when it comes to getting billionaires into debt: for example, lenders get a tax deduction and an incentive to make a loan because there’s a substantial interest rate premium compared with other types of financial instruments; and borrowers get access to the cash they might not otherwise be able to borrow without collateral.
It’s more common for highly successful businesspeople to be indebted than you may think, as there are a number of advantages that can be gained from taking out loans. It’s often easier for banks to lend money to people who are already wealthy because they can take advantage of assets such as stocks and real estate as collateral in case of default, and rich individuals have a better chance of getting loans since they’re considered less risky investments than other borrowers by creditors. For lenders, it’s not uncommon for them to seek out clients with sufficient wealth and no history of bankruptcies or losses because those individuals stand an increased likelihood of repaying their debts based on income alone.
Wealthy borrowers also stand a higher chance of securing lower interest rates because lenders are attracted to high-income individuals who won’t be put in a position of financial desperation by their monthly loan payments (making it less likely that they’ll walk away from their loans), and lenders can take advantage of tax breaks for providing those services. Whether a lender is seeking out business borrowers, rich investors or both, once those wealthy individuals are seeking credit, it’s easier to find an investor who is willing to provide financing even with higher interest rates.
Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence. John Adams famously said that a long time ago. It’s particularly true today as those of us who run our own businesses can attest to. Even billionaires aren’t immune to starting up in business with lots of debt.
There are two big factors that come into play for a business with a lot of start-up debt:
- 1) growth and
- 2) cost structure. In fact, 80% of wealthy entrepreneurs attribute their success to having started businesses that grew rapidly, according to Tom Corley in his book Change Your Habits, Change Your Life: Why Bad Habits Are Good and How To Make Them Better.
So, there are three major ways that a business can grow quickly:
- 1) Innovate with products or services
- 2) Innovate with cost structure 3) Innovate with distribution or selling channels. Each of these is a powerful way to get cash in your pocket, fast. There’s no way around it; growing your business will always cost you money—in time, effort and capital expenses—before you start earning income from operations.