Business

Improving Investor Behavior: Debt pulls your future forward (at a cost)


Steve Booren (handout)

Japan has 140 businesses that are more than 500 years old — operating around twice as long as the oldest companies in the United States. Nineteen of their businesses claim to have existed since the first millennium.

Let that sink in for a moment. From plagues to wars, natural disasters to collapsing economies, these ultra-durable businesses have encountered it all. And while no single characteristic can justify their longevity, one trait stands out: a lack of debt.

Steve Booren 

In fact, a study of Japanese businesses more than 100 years old conducted by the Japan University of Economics Graduate School found that more than 25% reported sufficient funds to operate for two or more years. Contrast that to the U.S., where two-plus years of cash flow merely sitting in savings would be considered near negligent by many shareholders. Our culture is one of growth at all costs, with resilience and longevity often taking a backseat to growing margins and higher market share — even if that means pouring reserves back into expanding the business or borrowing to achieve those goals.

Let’s start with a big example. The U.S. government spends about $6.5 trillion, with an income of roughly $4.5 trillion. Let’s break that down into relative terms. With a population of 360 million, that’s about $12,000 in income per person, and roughly $18,000 in spending per person. To make up the deficit, the government then borrows about $6,000 per person.

It doesn’t take a financial adviser to doubt the long-term success of this scenario. Anyone spending 50% more than they earn won’t sustain themselves for long. But cash flow is just part of the equation. The entire U.S. economy has a gross domestic product (GDP) of $29 trillion with total debt at about $36 trillion. The total value of all U.S. assets (business, public companies, real estate, the whole shebang) is estimated at roughly $500 trillion.

Again, big numbers can be hard to comprehend, so let’s scale them once again to a per person basis. Effectively, we can say the country is a business worth $1.3 million with $80,000 in sales (GDP) and $100,000 in debt. When scaled, do these numbers seem far out of line? I think not. This way of thinking puts debt into perspective.

Based on all of this, how should we think about debt?

Debt isn’t necessarily something you must avoid altogether. Rather, strive for the right amount, and type, of debt — while understanding that it raises your risk level. Debt combined with volatility impacts your ability to weather storms. As leverage increases, so does your overall exposure. And human nature leads most people to wildly underestimate their risks.

Consider that debt magnifies your gains and losses. When things are working in your favor, debt used as leverage can augment your return. But when circumstances change, that same leverage can multiply your loss. Today, the commercial real estate market is experiencing this firsthand. Large investors are throwing in the towel and selling prime properties at fire-sale prices, because the majority are over-leveraged while vacancies …read more

Source:: The Denver Post – Business

      

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