CW 798 - Thomas J. Anderson - The Value of Debt, How to Manage Both Sides of a Balance Sheet to Maximize Wealth & The Value of Debt in Building Wealth, Supernova Companies

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Welcome to the Creating wealth show. Episode number 798, 798. This is your host, Jason Hartman. Thank you so much for joining me today as we talk about the value of my favorite four letter word, debt. Yes, the value of debt. Our guest today will be Thomas J. Anderson. He's got a book series on this topic. We're going to kind of dive into it and explore good debt, bad debt, talk about the value of debt, the levels of debt that he believes you should have at different stages of life. Again, this is the guest opinion. Guests opinions are always their own. They are not necessarily my opinions, but I do like his philosophy in general about the value of debt and I think it's very appropriate. So we're going to dive into that in just a moment. But first, if you are thinking about joining us for the upcoming Venture Alliance Mastermind event in Las Vegas, I tell you, this is going to be a phenomenal, phenomenal Venture alliance weekend. We do these once a quarter. They are part of my exclusive Mastermind group and you can come one time as a guest. Visit venturealliancemastermind.com for more information. Look at the past events, check out the photos, the videos, learn a little bit about the Venture Alliance. It's for people who really want to take life to the next level and have some ad ventures as well. It's the Venture alliance and it's also the Adventure Alliance. So we have a lot of fun together and we will be at the Wynn Las Vegas. We have the former governor of Nevada speaking to our group. We've got some other great stuff lined up. We're going to have some very fun adventures. Hey, what happens in Vegas, stays in Vegas, right? So come on out and join us for that. That is March 10th through the 12th and you can also see some more information at Jason Har in the Event section. There are some additional photos and videos there. And join us as a guest or get a full membership, an annual membership to the Venture alliance and we will look forward to seeing you there. Also, our Memphis Property Tour is coming up in the not too distant future. What are we about? Well, I guess we're just over four weeks away from our Memphis Creating wealth seminar and our property tour there. This is our third Memphis tour and we look forward to seeing a lot of you there. Tickets are selling very briskly and very rapidly for that event, so don't miss it. Go to jasonhartman.com Click on the events section there as well for the Memphis Property Tour and if you have not seen it yet, make sure you take advantage of the free 27 minute video on how to analyze a real estate investment. How to Analyze a Real Estate Deal. It is the crash course in how to become a a good investor and it's totally free@jason hartman.com right there on the front page. So check that out. And without further ado, let's get to our guest and let's talk about the value of debt.

It's my pleasure to welcome Thomas J. Anderson. He is founder and CEO of Supernova Companies. He's author of really a series of books, but one of them is the number one New York Times best selling book, the Value of How to Manage Both Sides of a Balance Sheet to Maximize wealth. And the new book, the Value of Debt in Building Wealth. And you know me, debt is my favorite four letter word. So let's go ahead and dive in. Tom, welcome. How are you?

Thanks so much. I'm doing great. It's wonderful to be here. Appreciate it.

It's good to have you. And you are coming to us from the Windy City, Chicago, right?

Yes sir. It's a little cloudy today, but I think we're gonna have some spring weather around the corner.

There you go. Well, you really sound like you believe, given the title of your books, that debt is a good thing. Of course, all of us know that not all debt is good. Not all debt is created equal. There is consumer debt and there is investment grade debt and those are vastly different. But tell us about your beliefs surrounding debt.

Well, you hit the nail on the head. All debt is not created equal. And so I think that people can, you know, companies embrace debt, a strategic amount of debt. And I get that there's a difference between people and companies But I think we can learn from the practices of many of the world's greatest CFOs. And so to exactly what you're saying. I am against consumer debt and I'm against buying things that are stupid stuff you can't afford. But I am about having a strategy and a strategy that has the highest probability of success with the least amount of risk in accomplishing your goals. And debt can be a big tool to help you do that.

So lay out that strategy for us if you would. And I just want to make a comment here before you do that. Actually, it seems that the thoughts and opinions surrounding debt have really changed. When I started doing real estate investing seminars about 14, 13, 14 years ago, I had to kind of convince people of the power of debt. But it really seems like the word is out and most people get it. And this dramatic dramatically changed in 1971. And a lot of us for decades really, and some even still were kind of living out of our parents and grandparents playbook and old beliefs about debt when really the rules changed out from under them. Of course I'm talking about the gold standard and maybe we'll get into inflation and its effects on debt in our discussion. But just outline some of your beliefs about debt and why you say this and why you wrote the book series. And by the way, the series has three books, right?

Yes, there are three books. The first one is the Value of Debt. The next one was the Value of Debt in Retirement. And then we moved into the value of Debt and building wealth. And each book is basically trying to get more specific to a lot of the things that you're addressing. I think from a big picture perspective, you know, where I started with the Value of Debt is basically saying, look, companies have optimal debt ratios. Look at something like Apple. You know, they have billions and billions of dollars of cash, yet recently they've been issuing billions and billions of dollars of debt. Why is that? Well, they value the liqu. The flexibility and the tax benefits associated with that debt. And it's strategic debt. Debt that they could pay off, but that they're choosing to have. And where you're way ahead of the curve compared to many people is you're hitting the nail on the head. It's not just about, as you said, consumer debt. And I think the word is getting out and generations are changing that. If you have the right debt, the right way, it can be a very powerful tool. Now what I did in the first book, and then we incrementally went more specific was I started out with a framework using what companies do, but I made it more conservative. The companies are in the business, of course, of probabilities, where people are in the business of surviving first and foremost. So for people that are more familiar with debt, like you, a lot of people are surprised with my conservative nature, but I try to take a balanced middle ground and make sure that people have an optimal amount.

Okay, so what is the optimal amount? And it depends on age and life stage, right?

It absolutely does depend on age and life stage.

So how many life stages do you divide up into and then tell us the optimal amount for each stage, if you would.

Yep. So I basically break life into four stages of life, which the acronym is life. The first one is launch, when your net worth is less than 50% of your annual income. So for easy math, if you have an income of $100,000 and your net worth is less than $50,000, then you have one type of risk in your world and should have one type of debt. The next phase is independence. Independence is when you're really between, you know, 50% and two times your annual income. So if you have a hundred thousand of income, your net worth is between 50,000 and $200,000. Then I move you into freedom when your net worth is between two and five times, and then what I call equilibrium, which is between 5 and 20.

Times, and give us the debt amount for each of those stages. Though you didn't quite say it, although if someone did the math. But I just want to make it really easy for our listeners. So that first stage, the launch stage, you gave the example of someone making 100,000. I believe in income and what's their debt and tell us the debt amount for each stage.

Yeah, so the book is designed to be very specific and actionable where its debt ratios. Actually what I did is I took the Fibonacci sequence or the golden ratio, and I applied it to your life in different stages. So in my earlier works I've said that a 30% debt ratio is kind of an optimal number. But earlier in life we'll tend to take on more debt to, you know, buy a house and have things that we otherwise could not afford. So your debt ratio kind of moves throughout the phases. And so to address it specifically, the theme is that until you have a net worth More than 50% of your annual income, I really want you to be conservative and avoid debt. So many people are check to check. They take on too much consumer debt. They don't have enough money in their checking and savings account. And so in those early phases of life, I want people to just build up liquidity and really minimize taking on debt and that first phase.

All right, so give us the number though. What's the number?

Well, basically in the launch phase, I really like zero debt. Build up your retirement plan, build up your checking account, build up your savings account. Don't take on debt until you have some cushion of liquidity. So many of the bad debt stories that you've heard that you earlier were addressing are people that take on too much debt too early in life before they have some liquidity.

Okay, but this person's doing pretty good. They're making $100,000 a year. So I thought you were going to say they could have $50,000 in debt. I thought that was the equation.

Yeah, a lot of people would have thought so. And what my whole theme is is that early in our life, and hopefully you embrace my approaches before you're making $100,000. But right when people get out of school, they're in their 20s, they're in their 30s, too many people take on oppressive debt. They have credit card debt and they just don't have money in their checking and savings account. And so what I really want people to do early in their life, until you get to 50% of your annual income, which you should be able to hit with a little bit of savings. It shouldn't take long to break through that phase, but so many Americans don't. I want you to be very cautious with debt during that first phase. Once you're cautious in that first phase, you now have a foundation where we can take on higher levels of debt in the other phases.

Okay. And I mean, and. But it just begs the question, doesn't it, Tom, that we've gotta, we've gotta, we can't just say debt. We did distinguish good debt, bad debt. Not all debts created equal. But what kind of debt? I mean, if someone is 25 years old and they're making 100,000 a year and they buy a rental property where you've got what I call self liquidating debt, in other words, the tenant pays the debt for you. How do you, you know, see these equations are, they get kind of complicated, don't they? Because it's different when the debt is for, you know, that, that swanky new car versus you know, that you have to pay the debt yourself or your own home where you got to pay your own debt, or you know, certainly student loans and all that kind of stuff. But if you have, if you're outsourcing the debt to another party. Does that apply the same way? Or how do you, how do you bring that into the equation? Or can you.

Yes, you're asking all the right questions. And so the way that I look at that generally, I think most, most people should have less debt early in their life and more debt later in their life than conventional wisdom would say.

Yeah, because most, most like financial advisors and that's your background by the way, is, would say the opposite. They would say when you're older you should pay off all your debts, you own your house free and clear, own all your rental properties free and clear, don't have any. And when you're young, you know, you got energy and time and you know, go ahead and take on the world. Right. You're saying the opposite, aren't you?

So. Yes. And you and I are going to be on the same page literally right. When I get to the independence phase, it's in that launch phase. So things that, where people find or are surprised with my opinions generally I believe that until your net worth is 20 times your annual income. So if you make $100,000, until your net worth is more than $2 million, I'm going to.

That's a tough equation for most people.

Yeah.

Okay.

Until you have that level of net worth, I need you to have debt and I need you have the right debt, the right way at the lowest possible rate, owning income producing assets to your exact point so that you have a higher probability of success in retirement. So throughout life. I know you and I are on the exact same page there, but this nuanced part is not insignificant phase of life. Two people are too quick to take on debt, but they aren't prepared for the curve balls that life can send us. And so before people take on debt, even if it's good debt, even if it's investment debt, even if it's self liquidating debt in that launch phase, I really just want people to have some cash and some liquidity and then they can be much more strategic and ride out the storm. So that's a piece of my advice that's a little bit more conservative. But it's if you break that check to check cycle and have some liquidity, you won't get into all the troubles with debt that other people have had.

Okay, good point. So we got kind of stuck on the launch phase because I asked you a bunch of clarifying questions there.

They're great questions.

But say the amount for each phase. I want to make sure the listeners get your take on that.

Yeah. So the book is specific Glide paths with worksheets designed for all income levels. But essentially when you're looking at the independence phase, I say now you're in a position to take on potentially a higher level of that some people might think typically what you're trying to do in that phase is buy a home. And so I say, you know, you might want to take your monthly income times 39, and that can be a very interesting level to be considering there's math behind the 39, but that's the exact number. So let's say that I had $5,000 a month of income, that'd be about $195,000 mortgage. And maybe I'm buying a house that's a $240,000 home, which would be the average price of a home in the United States.

Okay, so what's the next phase?

So then from there, what you're coming into is the freedom phase. And what I like to do in the freedom phase is this is counterintuitive, but that works out to be a debt ratio that's closer to that 66, 70% number early on. So I think you do leap up to a higher level of debt. And in the freedom phase, my whole theme is that there are two ways for your debt ratio to fall. Way number one is you can pay down your assets, pay down your debt. Excuse me. Or way number two is you can build up your savings. I do not want you to pay down your debt in the freedom phase at this point in time. Regardless of where your debt is, no matter who you are, if your net worth is between two and five times your annual income, you need to build up more assets so that you can have a secure retirement. So if you have debt at a rate of less than 5%, or maybe debt that's, you know, tax deductible, you know, like a mortgage and so forth, don't pay that down. Instead build up assets and that will mathematically improve your chances of long term success dramatically because your money's compounding for a longer period of time.

Yeah, well, I absolutely agree with that. And the part you didn't mention is on that mortgage, even if it's not self liquidating debt, even if it's your own home, of course this is dramatically better on an, on an income property, on a rental property. But even if it's your own home and you're paying the debt yourself, if you're borrowing that money at just for round numbers sake, 5% and inflation is two and a half and your tax bracket is 40%, I mean you're basically getting it almost for free. You're not paying any interest really. I mean nominal amount by the time you get your tax advantage and then inflation kicks in to debase part of that debt for you. Pretty good deal, isn't it? I mean, it's just amazing. Like the people that don't realize debt can be an asset and a very powerful tool, they, they miss that, they miss out on this, don't they?

Absolutely. And as you keep saying, which I can't reiterate enough, it's the right type of debt, the right way. And so if you, it's very powerful. But these themes of inflation and appreciation and income on the underlying assets, that's what you need working for you for a 30 year period of time. I think so many people are so debt averse that they take good debt, race to pay it down, wake up at 50 years old and say, oh my gosh, I'm under saved for retirement and try to save in 15 years and you just can't save enough money or have enough rate of return to make it in that period of time. You need to embrace a strategy throughout your life.

Yeah, you know, let me remind everybody that nobody ever got rich saving money.

But you know, saving is better than blowing it all with, you know, careless, indulgent, instant gratification things too. So understand there's a balance. When I, when I say that, it just amazes me and I fell for it too. Very early in my real estate career I used to think that, oh well, you know, making bi weekly mortgage payments or paying one extra payment per year, you know, pay your mortgage down in 18 years instead of 30. I used to think that was a good strategy. Now I think it's absolutely idiotic. You've got this incredibly cheap debt. It's tax deductible if it's on your own home. If it's on a rental property, it's self liquidating because you're outsourcing the debt to someone called a tenant. They pay it and hopefully they pay you a little extra every month too to put in your pocket. It's just, why would you rush to pay that off? It makes no sense. That's fantastic debt. Dave Ramsey will never get that, will he?

Well, and you know, while there are very big opportunities and rental properties and so forth, I think what happens within mortgages is.

There'S just this balanced view between like what Dave says or people who just go too speculative and they try to do, you know, have no liquidity, no reserves, no money down on any of the property properties and just keep pressing and rolling. How do we get to a balanced middle ground and.

Well, well, the first problem with them, by the way, since I'm the real estate guy, is they buy properties that don't make sense in the first place. They're speculators, they're gamblers. And you know, of course you better, if you're going to gamble and speculate, you better be doing it with a very small portion of your net worth and you better have adequate reserves to save yourself because you never want to be forced to liquidate at a bad time.

You are so right.

Sustain power is the name of the game.

You know, what I get surprised about with a lot of real estate investors is that they won't do exactly what you're saying. There's two things. Number one, they just kind of buy and hold forever. I think a lot of successful real estate investors think about Sam Zell. He'll come in during a crisis, buy a whole bunch of properties at really cheap prices, and then he has a huge return, sells them, builds up cash, repeats. The other thing a lot of real estate investors don't do is. But real estate prices definitely go up and down. And so if you have, you know, too much leverage on an overpriced asset, that's always going to be a bad idea. If you're buying it in 2000, you know, 8, 9, 10, that's a great idea. So similarly, real estate investors, because of the cyclicality of real estate, need to have liquidity because what if that 10 it moves out? That shouldn't be a exogenous. It needs to be in people's base case scenario. So.

Right, absolutely. A lot of these people in, in any investment, whether it be stocks, bonds, mutual funds, real estate, I mean, I don't like any of that stuff other than real estate. But you never, you know, it's always boils down to a game of staying power. And it's not always wise to stay in the game and be stupidly stubborn. But you, you always want to have that choice. You never want to be forced to liquidate at a bad time. That's what market cycles do to people. And it's also, there's another thing that does that to people. It's the big D word. It's divorce. It forces people to liquidate, you know, assets at the wrong time. Marriage counseling can be a very good investment in a bad economy, if the market is down, stick together.

There's no doubt about that.

It's. And actually you have a really important point There, that's, that's worth discussing further. Let's say that you're a real estate investor and you have a rental property and you also have a home. If you take $100,000 and you pay it down on your house and a crisis comes and you lose your job, you can't get that $100,000 back because you probably can't refinance because you, you.

Don'T have your loan.

Exactly.

Right, right. And, and it's even worse than if things, if, if things get bad. The people who get all the breaks, it's not fair. It's just the way it is. Okay, I don't think it's fair, but it's reality is, are the people who are highly leveraged on their real estate. At least. You know, when, when Katrina came along and wiped out a bunch of people, the mortgage companies did a moratorium on mortgage payments. If you owned your home free and clear, you got nothing. Okay? I mean, you got nothing. When, when the economy has, has gone through its cycles, people do short sales, they do workouts, they get loan modifications. And you know what, people with a lot of equity, they, they get turned down most of the time on that stuff. It. That they become actual foreclosure targets. Because if you're, look it, if you're a lender and you're analyzing a portfolio of 10,000 mortgage loans that you've got out there, and you look at the ones with 50% loan to value and the ones with 100% loan to value, maybe they were originally 20% LT or you know, 80% loan to value, but then 20% evaporated in a down market. You know, you're not going to foreclose on the people with 100% loan to value. There's nothing to get, there's nothing to gain. So the people you want to foreclose on are the people with the most equity. Because you've got a safety margin as the lender, you become prey. Okay? So if you're highly leveraged, it's counterintuitive. The lender calls you up, they send you a letter, hey, we know things are tough. Can we help? Can we modify your loan? Do you want to do a cooperative short sale and sell it and we'll let you off the hook? It, it, it's so wrong and unfair, but it's reality. It's the way it, it's the way the world is. And I saw it happen in two cycles. I saw it happen in the 90s, and I saw it of course happen in the last cycle where millions of people just, they got breaks, they got, you know, the lenders just let them off the hook, incentivized by the government through the bailouts, the TARP programs and so forth. So any thoughts on that?

I think that you're absolutely right. I mean, you know, in a down market, banks are definitely willing to, to work with people that have debt. My goal is that all of that ends up being avoided by having cash and liquidity to ride out the storm. And so.

Markets will go down, real estate prices will go down at different points in time. Floods will happen, hurricanes will happen, people will lose jobs, people will be divorced. I think the biggest thing that we're 100% on the same page here is if you have money in the bank, it's an insurance policy against all of that. If I have 100,000, $500,000 in cash, that'd be a lot, Right? But instead of paying down on that debt, the liquidity and flexibility that you pick up in all types of scenarios, including the ones you just went through, is vast. Embrace that flexibility. Flexibility is valuable.

That cash is what gives you flexibility. So the property is not a good bank. The bank is a better bank than the property because the bank allows you to withdraw the property. They allow you to withdraw when you don't need it very much.

That's exactly right.

When you're, when you're, when you're well employed, when the market is up, yeah, you can withdraw money out of your house, no problem. But when things turn the other way, that, that lending dries up really quickly. So, yep, have, have control of that, that equity outside of the property. And that's why I very much believe in the concept of equity stripping. What else from any of your books, Tom, do you want to tell the listeners? I don't want to just, you know, hound on this real estate thing forever, and I know we got to wrap up, but anything I didn't ask you or cover, you didn't cover yet that you want to share.

You know, I think.

What we're talking about is how the investment side of the equation is important relative to the debt side. And with a little bit of debt struck the right way, you don't have to have massively outsized return. So forget about the days of, you know, 10% returns or 8%, but if you can have a return of 6% and borrow at a cost because of tax benefits and everything else, as you were going through of, you know, 3%, you combine a little bit of inflation through time, a lifetime of 35, 40 years, these spreads widen dramatically. And so I don't want people swinging for the fences. I think that it's a risky time with where interest rates are, with where the stock market's near all time highs, bond markets basically near all time highs. Real estate is a tricky market, but.

Certain prices, the bubble markets, the cyclical markets, South Florida, most of the west coast, the expensive east coast, northeast areas, I mean those markets are just totally overvalued if you ask me. Now does that mean they're going to crash tomorrow? I don't know. Nobody does. But they are definitely way past the point of fundamentals. So be very careful. If you're, if you're thinking about buying a property in Los Angeles or Miami or San Francisco or Boston or New York, you better really be careful. Those are, those are gamblers paradises, you know, they're just very speculative.

So I spoke at a conference in Miami and there were a bunch of real estate people there and someone bought a property, property for around one and a quarter, I think like $1.25 million. Properties worth about $3 million they say. And I said, that's amazing. Would you sell it for three and a half? And what do you think the answer was?

No, it's going to be worth more. It's going to be worth 5 million, right? Yeah, typical.

Yeah, that's exactly right. I said would you sell it for four? And they said no. And I said at what price would you sell it? And basically. And there was no price at which they would sell it. And so like that's that. So I believe you're exactly right. Many of these markets are. If you have a bunch of people who are buying just saying there's no price at which I would sell, that's when you start to see some signs that there could be some trouble.

Yeah. And when everybody's a genius. Yeah, I always like to say everybody's a genius in a bull market, aren't they? Yes.

It'S really scary. It's like that Rockefeller thing, I think, you know, he said, when I start getting stock advice from my shoeshine boy, you know, you know, we're in bubble territory. Yes, very, very good point. Okay, give out your website if you would tell people where they can find out more. Of course, the books are on all the usual places and just. Any closing thoughts? Wrap it up for us if you would.

Yes. If you welcome to check out valueofdebt.com there's information on all three books. I'm most proud of the recent one here. The value of Debt and building wealth, which is a specific and actionable glide path for everybody regardless of their net worth on how the right amount of debt, the right way can increase the probabilities that you'll be prepared for emergencies and not run out of money on your life journey.

Good stuff. And give out your website or did.

You it's value of debt.com value of.

Debt.Com okay, you can also check us.

Out@Supernova companies.com but the main education site for books is valueofdebt.com that's what I.

Was saying because I noticed here yet a couple three different websites. So good stuff. Well Tom Anderson, thank you so much for joining us and enlightening people as to the Value of Debt. I think it's an incredibly powerful tool. It needs to be used with respect like any tool, but it is definitely very powerful. So appreciate you sharing today.

Well, I really appreciate your perspective and thanks for having me on.

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