Debt often gets a bad reputation, but when used wisely, it can actually be a powerful tool for building wealth. In this article, we'll break down the difference between good and bad debt, explore how debt can be used strategically, and dive into how some of the wealthiest people in the world use debt to their advantage.
Let's explore how debt, with a proper strategy, can actually work for you—not against you. Understanding the mechanics of leverage is the first step toward using it safely.
⚠️ Educational Overview — This article provides a high-level educational overview of how debt works, written for investors analysing companies and personal finance concepts. Check Your Stocks is not a licensed financial, tax, or legal advisor. Tax treatment varies significantly by country and jurisdiction. Always consult a qualified professional before implementing any debt-based strategy.
A Smart Financial Plan Is the Foundation
Borrowing is often seen as a financial burden, but with a well-thought-out financial plan, it can become a wealth-building asset. This plan should outline your financial goals, track income and expenses, and include a smart debt strategy.
Start with the basics:
- Create a budget that shows exactly where your money goes.
- Build an emergency fund to cover unexpected expenses.
- Focus on paying off high-interest debt before borrowing again.
When these pieces are in place, debt can become a useful tool. For instance:
- Student loans can fund education, which often leads to higher income.
- Mortgages can finance real estate investments that appreciate over time.
- Low-interest loans can be used to invest in high-yield opportunities.
The key is to align borrowing with your financial goals and use debt intentionally—never emotionally.
Debt vs. Equity: The Corporate View
When you analyze a company using our Stock Screener, you will notice that almost every corporation carries debt. Companies use debt to fuel expansion without diluting existing shareholders. For an individual investor, using a mortgage to buy an investment property is conceptually similar to a company issuing bonds to build a factory. Both are using calculated leverage to increase the return on equity (ROE).
Bad Debt vs. Good Debt: Know the Difference
Not all debt is created equal. Knowing the difference between good and bad debt can help you make smarter borrowing decisions.
Bad debt often includes:
- High-interest credit cards (especially when balances aren't paid in full).
- Auto loans for new cars that rapidly depreciate in value.
Even when buying a used car, it's crucial to:
- Shop around for the best loan terms.
- Make sure the purchase fits within your budget.
- Avoid borrowing more than necessary.
Remember: even good debt becomes bad when it gets out of control. Borrowing for a home or education can backfire if the amount is too high for your income. Always balance your lifestyle with a repayment plan that keeps you on track.
Know Your Debt Tolerance
Before you borrow for investments or big goals, it's important to evaluate how comfortable you are with taking on debt. This is your tolerance.
Ask yourself:
- Can I handle market ups and downs if I borrow to invest?
- Am I flexible if repayment takes longer than expected?
- Does my income support this new debt?
Understanding your own comfort level and ability to repay is essential. There's no universal answer here—each person's situation is different.
If you're unsure, working with a financial advisor can help tailor a plan based on your income, risk tolerance, and goals.
Borrowing to Invest: Gearing and What It Means for Company Analysis
Gearing — borrowing to invest — is a concept you will encounter constantly when analysing businesses through our Stock Screener. Most companies use gearing as part of their capital structure, and understanding it is essential for evaluating balance sheet health.
Key metrics to look for when assessing company gearing:
- Debt/Equity ratio — how much debt the company carries relative to shareholder equity. A ratio above 1.0 warrants closer scrutiny.
- Interest Coverage (EBIT/Interest) — how many times over the business can cover its interest payments. Below 3x is a warning sign in most industries.
- Debt/EBITDA — a proxy for how many years of operating earnings it would take to pay off all debt. Value investors generally prefer this below 3x.
For individuals, the same logic applies: borrowing to invest (e.g., mortgage for a rental property, or a margin loan for stocks) can accelerate returns, but leverage amplifies losses just as much as gains. Interest on such loans may be tax-deductible in some jurisdictions — but rules vary widely.
Debt Recycling: Turn Bad Debt Into Good
Recycling is a clever way to turn inefficient loans into productive, wealth-generating debt. Here's how it works:
Let's say you receive a large sum of money—like a bonus or inheritance. Instead of just spending it, you use it to pay down bad debt (like a personal loan or non-deductible mortgage). Then, you take out a new loan for investment purposes—one that may offer tax advantages.
This approach doesn't reduce your debt right away, but it shifts your borrowing toward productive use. Over time, this can significantly grow your wealth. Just keep in mind that this strategy also involves risk, so consulting with a financial advisor is essential.
Student Loans: Investing in Yourself
Not all debt is about financial investments—some of it's about personal growth. Student loans, for example, are a way to invest in your future.
While they are technically debt, they fund education, which can lead to higher-paying jobs and long-term career growth. In that way, they function more like an investment in your human capital.
Used wisely, student loans can unlock greater income potential and job opportunities. They're not just a burden—they're often a stepping stone to a more secure financial future.
Business Loans: Fueling Entrepreneurship
For entrepreneurs, commercial loans can be one of the smartest uses of debt.
These loans allow businesses to:
- Purchase essential equipment or inventory
- Hire talented staff
- Fund initial growth stages without draining personal savings
The interest on business loans is often tax deductible, which can ease the financial burden and support long-term profitability.
Using business loans strategically also helps separate personal and business finances, protecting your personal wealth while growing your business.
How Some Wealthy Individuals Use Debt Strategically (Descriptive Overview)
⚠️ High-Risk Strategies Ahead — The strategies described in this section are complex, jurisdiction-specific, and carry significant risks including margin calls, asset concentration, interest rate exposure, and changes in tax law. This is a descriptive overview, not a recommendation. Consult a licensed financial and tax professional before considering any of these approaches.
Observers of ultra-high-net-worth individuals often note a pattern in how some structure their finances. Rather than selling appreciated assets (which would trigger capital gains tax in many countries), some choose to borrow against those assets to fund lifestyle or further investments.
- High-net-worth individuals often hold large equity positions they prefer not to sell — selling would realise capital gains and trigger a tax event.
- Instead, they borrow against the value of those assets. Loan proceeds are generally not considered taxable income in most jurisdictions.
- This allows access to liquidity without triggering a taxable event — though the debt carries its own costs and risks.
This approach is legal where it applies, but it is highly sensitive to interest rates (borrowing costs can rise), asset valuations (a market decline can trigger a margin call), and tax law changes. It is not a widely applicable personal strategy and carries substantial complexity.
Final Thoughts
Debt isn't always the enemy. When approached with intention and guided by a solid plan, it can actually become a stepping stone to financial freedom. Whether it's investing in your education, growing a business, or buying appreciating assets, good debt used wisely can help you build the life—and the wealth—you want.
Note: Tax strategies vary by jurisdiction. Always consult a licensed tax advisor before implementing debt-based tax strategies.
Want to see how debt-fueled investing stacks up against traditional saving? Use our Portfolio Compound Growth Calculator to model both scenarios. You can also explore how companies use debt by checking any stock in our Stock Screener—look at the Debt/Equity ratio in the fundamentals tab. For a related read, explore our guide on Assets vs. Liabilities.
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