Is debt smart for your plan?
Intelligent borrowing, especially at today’s low interest rates, can be a useful tactic.
When most people think about their finances, they focus on assets – stocks, bonds, property and cash. But those represent only one side of a personal balance sheet. The other side – liabilities, or debt – is equally important. And while you need to keep your liabilities at a manageable level, strategic borrowing, particularly at today’s historically low interest rates, can be an essential part of your overall wealth management strategy.
Many investors consider it best to avoid debt entirely or to clear it as quickly as possible. That makes sense if you’re paying off a highinterest credit card balance. But other kinds of loans can help diversify and strengthen your balance sheet. Your Financial Advisor may know of various ways debt could actively help you purse your financial goals.
“Diversification is a useful framework for thinking about debt,” says Michael Crook, Head of Investment Planning at UBS CIO Wealth Management Research. Most investors have already embraced one form of debt as an instrument for building value, of course. “When you take out a mortgage to buy a home,” Crook says, “you’ve added equity in a house to the asset side of your personal balance sheet.”
While each family’s situation is different, here are a few guidelines for using debt wisely.
Key takeaways
•Smart use of debt is an important part of a well-balanced financial plan. •Use debt to diversify your assets, such as taking out a mortgage to purchase a home.
•Analyze potential borrowing in the context of your complete financial plan to determine whether debt will help you achieve your financial goals.
•Maintain control of debt by keeping enough cash on hand to pay liabilities and locking in long-term rates.
•Review debt against changes in interest rates and your financial situation to potentially improve your positions.
Borrow to build value, not increase spending
There is a difference between using a credit card for discretionary purchases and taking advantage of other kinds of borrowing that could benefit your overall balance sheet.
You could take out a loan to pay for a child’s or grandchild’s education, boosting his or her future earning power.
Or suppose you face a large tax bill.
If you sell stock to come up with the money, that sale might trigger still more taxes on capital gains, and it might mean parting with shares that could increase in value. Instead of selling those investments and paying the additional taxes that sale would incur – while also losing the possibility of future earnings of those investments – you could consider borrowing and using those shares as collateral.
Borrowing instead of selling means avoiding that additional tax hit, and keeping the possibility of the shares’ increasing in value in the future.