The Value of Debt: How to Manage Both Sides of a Balance Sheet to Maximize Wealth

Contents

Foreword

Acknowledgments

Introduction

Part 1: The Value of Debt in the Management of Wealth

Chapter 1: Strategic Debt Philosophy: An Overview

How This Book Can Add Value to Your Life

The Five Tenets (or Action Principles) of Strategic Debt Philosophy

Chapter 1: Summary and Checklist

Chapter 2: The Basic Idea: Limiting the Costs, the Impacts, and the Duration of Financial Distress

Risk of Financial Distress

The Direct and Indirect Costs of Financial Distress

The Impact of Financial Distress: Five Levels

The Duration of Financial Distress

The Four Indebted Strengths: A First Look

The One Thing You Must Consider!

Chapter 2: Summary and Checklist

Chapter 3: Strategic Debt Practices: An Overview

Understanding and Taking Advantage of Strategic Debt Philosophy

Achieving and Maintaining an Optimal Debt-to-Asset Ratio

Calculating Your Debt-to-Asset Ratio

Should Your Primary Residence Be Included in Your Debt Ratio?

When to Pay Down Your Debt, and When Not To

Advanced Practices and Scenarios

Chapter 3: Summary and Checklist

Part 2: The Assets-Based Loan Facility

Chapter 4: The Value of an Assets-Based Loan Facility (ABLF)

What an ABLF Is and How It Works

The Many Advantages of Having an ABLF in Place

Why Virtually Every Company Has a Line of Credit

Surviving Storms and Other Natural Disasters

The Criticality of Being Proactive and Assessing Risks

Family Finances: First Bank of Mom and Dad; Elder Care Bridge Loan

Taking Advantage of Opportunities and Distressed Sales

Average ABLF Usage and the Win-Win-Win Scenario

Chapter 4: Summary and Checklist

Part 3: Scenarios for Success

Chapter 5: Long-Term Wealth Amplification through Capturing the Spread

The Basic Concept: Inherent Risks with Great Potential Rewards

Three Key Factors to Consider

Some Scenarios for Capturing the Spread

Synching with Your Investment Strategy

Chapter 5: Summary and Checklist

Chapter 6: Holistic Financing of the Expensive Things You Need and Want

A Better Way to Buy: In the Company of Holistic Financial Thinkers

Four Principles When Financing the Purchase of a Desired Item

A Better Way to Purchase a Vehicle (or Almost Anything Else)

Purchasing a Second Home: Pluses and Minuses

100 Percent Financing: The No Down Payment Real Estate Purchase Option

Chapter 6: Summary and Checklist

Chapter 7: Generating Tax-Efficient Income in Retirement or Divorce

Introduction: Three Goals (and Some Disclaimers)

An Opening Scenario for No Taxes in Retirement

Borrowing Versus Selling to Access Your Money

A Better Alternative to a Familiar Story

Tying It Back to Capturing the Spread

Revisiting Tax Issues

Making Use of Strategic Debt Strategies and Practices in Divorce

Chapter 7: Summary and Checklist

Chapter 8: Conclusion: What This Book Is Really About

What We Hope You Have Taken Away

Strategic Debt as a Financial Engine over the Decades

Paradoxes of Plenty: Some Surprises in Maintaining an Ideal Debt Ratio

Investing in the Future: A Cautionary Reminder

A Final Thought

Chapter 8 Summary: A Recap of the Book’s Significant Lessons

Part 4: Appendixes

Appendix A: The Varieties of Debt

Appendix B: Strategic Debt Practice for the Young and Those with Limited Assets

Appendix C: No Guarantees: Limiting the Risks of Investing in a Crazy World

Appendix D: Some Examples of Ideal Debt Ratios

Glossary

Bibliography

About the Author

About the Companion Website

Index

Cover image: © iStockphoto.com/Feng Yu

Cover design: Paul McCarthy

Copyright © 2013 by Thomas J. Anderson. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.

Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Anderson, Thomas J. (Certified investment management analyst)

The value of debt : how to manage both sides of a balance sheet to maximize wealth / Thomas J. Anderson, CIMA, CRPC.

pages cm

Includes bibliographical references and index.

ISBN 978-1-118-75861-8 (hardback); ISBN 978-1-118-75851-9 (ebk);

ISBN 978-1-118-75863-2 (ebk)

1. Finance, Personal. 2. Debt. I. Title.

HG179.A55976 2013

332.024′02—dc23

2013020675

For Sarah, John, Rosemary, and Oliver

Foreword

Change is the one constant in the financial services industry. In 1970, there were many days where trading volume on the New York Stock Exchange did not exceed 10 million shares. Recently, there have been multiple days with over 5 billion shares traded, an increase of 500 times. We have seen the development of integrated money market accounts, explosive growth in mutual funds, and the proliferation of such instruments as exchange-traded funds, separately managed accounts, hedge funds, private equity, structured products, and managed futures for commodities. This is taking place not just in the United States but across the world.

With time, advice has evolved as well. It had to. Clients have more investment choices than ever before. The global economy has become more interconnected and global capital markets have gone through explosive growth in both size and depth. The financial services industry has listened to the demands of its clients and responded accordingly. Investors today have the opportunity to invest in more asset classes through more vehicles in more places around the world than ever before.

So, where do we go from here? I had the opportunity to visit with Tom Anderson while he was putting together this book and he pointed out a glaring omission that I believe holds true for most all of us: throughout his primary school years, college education, graduate school, and professional life, Tom had not been educated as to the virtues of correctly structured debt. One can fill a library with books on debt strategies and capital structures for corporations, but there is virtually no material on the subject for individuals or families. Why? As I reflected on this some more, I found it shocking that there is not more material, education, debate, and discussion on this topic.

The financial industry has largely treated debt as though it were an outside force, considered and controlled independently of the rest of an individual’s financial life. But who has not used a mortgage to finance a home, obtained a student loan to cover college tuition, or borrowed to buy a new car? It seems common sense to treat these moments of capital acquisition holistically, as part of an overall financial plan. However, this happens all too infrequently in practice. While most financial firms and advisors today are able to deliver integrated solutions by and large, they are not yet delivering integrated advice.

Most advisors give sound advice when it comes to equity but overlook the other half of the balance sheet. Getting sound advice on liability management can be critical especially during those first years of retirement. Tom has written a must-read book for anyone looking to make better financial decisions. This book should be a staple for Financial Advisors who want to do a complete job of advising their clients.

Tom’s background, at some of the top schools in finance in the United States and abroad, combined with his experience in investment banking and as a financial advisor, affords him a unique perspective to address this gap. His ideas come together in this book to deliver a new perspective that represents a substantial step forward toward a cohesive solution.

The excesses of debt and reckless lending at the heart of our recent financial crisis have been well documented. This is no reason to ignore debt as an effective financial arrow in your quiver. In fact, it’s all the more reason to approach debt in an intelligent and educated fashion. What’s true about investing is that it entails risk, yet can offer rewards. The same principle applies to a debt philosophy.

The ideas expressed in this book may or may not be appropriate for your individual situation. The most important contribution of this work is that it should create more questions than answers. These questions in turn should lead to quality, holistic conversations about all aspects of your financial life with your tax, legal, and financial advisors. Change is constant, but as the book describes, with integrated, holistic advice we can be better prepared for this change, and for the future ahead.

Robert D. Knapp

President

Supernova Consulting Group

Author of The Supernova Advisor: Crossing the Invisible

Bridge to Exceptional Client Service and Consistent Growth

Acknowledgments

This book is an amalgamation of all aspects of my education and career. I wish to thank my many professors at Washington University and The University of Chicago—you have greatly influenced this work. To Professor Jaffe from the Wharton School of Business, I’ll never forget the CIMA final exam, and I hope you see how often your textbook is cited in the endnotes, for those who want additional detail on corporate finance.

My coworkers from my time in investment banking in wealth management inspire me; I have learned from each of you.

Carl Klaus defined the value of debt as the unique idea to develop into this book. His advice and guidance have been invaluable. Molly Chehak taught me about the process of creating a book and the publishing industry.

Phil Burrelle, I appreciate your modeling assistance. John Osako and team at Informatics, thank you for your amazing technical support.

Rafe Sagalyn, you are an outstanding agent, and I sincerely appreciate your guidance. David Zylstra and Denny Redmond, I value your advice and counsel.

Jordan S. Gruber turned my initial ideas and writing forays into an actual publishable manuscript, and I can’t thank him enough for his incredible efforts. He is an artist and helped me express complicated ideas in an easy to understand language. RJ, I am so grateful that you introduced us.

I would like to thank the following readers for their thoughtful and insightful advice: Greg Boester, Alex Dunlap, Jim Harris, Dr. Curt Hass, Kate Hladky, Jim Hoffman, John Huey, Dave and Patricia Knuth, Randy Kurtz, Chris Merker, Eliot Protsch, Dr. Jerry Shirk, Dick Siders, Julianne Smith, Nathan Swanson, and Steve Vanourny. The book is a better book because of you.

To the incredible team at Wiley; thank you for all of your support through the development and production phases of this book. Tula Batanchiev has been my North Star and guided me through every step. Judy Howarth, my development editor and Melissa Lopez, my production editor were invaluable to me; I appreciate their superb editorial skills. Any remaining mistakes are my own.

Mom, thanks for sending me to Wall Street Camp when I was 16; I wouldn’t be in the industry without you. I value your advice and treasure your love and support.

I would particularly like to thank my team: Kerry Abdoney, Jon Bancks, Stacey Halyard, Darla Lowe, JoAnn Masters, Fred Rose, Julie Vogt, and summer analyst Ben Rees. You not only made tremendous contributions to this book, but also enabled me to dedicate time to writing this while maintaining growth and excellence within our practice.

Kids, I love who you are and who you are becoming. I am proud to be your father. You give me more joy than I ever thought was possible.

Sarah, you are an incredible partner in every aspect of my life. None of this would be possible without you. You make me a better person and I enjoy life more because of you. I love you.

Introduction

Who is this book for? This book is not for everybody. To make best use of it, there are three prerequisites, as follows:

1. First, you should have an open mind.

2. Second, you should probably be working with a progressive, holistic financial advisor or private banker who also has an open mind and who can help you implement the strategies, practices, and tactics that will be suggested here. (If you happen to be a financial advisor or private banker, then please consider the book as being meant for you too, as well as for your appropriate clients. The ideas found here may help you do a much better job for at least some of them.)

3. Third—and this is either something that will be true for you at this point or may be true for you at some point in the future—you will need to have sufficient investible assets to implement these ideas. Sufficient assets is intentionally vague. Initially the book was written specifically for Accredited Investors (particularly those with a net worth of more than $1 million, excluding their primary residence) and you should approach the material with this in mind. However every situation is unique and you will have to work with your advisors to see if these ideas are appropriate for you and your family based on your assets, income, goals, and objectives.

Now, if you don’t yet have sufficient investable assets, you very likely will still find many of the ideas useful and interesting, and something to aim at incorporating into your financial life over time. However, many of the book’s concepts and principles simply cannot be effectively applied to individuals without a high enough net worth. In fact, many of the ideas could have a very negative effect if used by lower net worth individuals, particularly if the concepts are misapplied. Nonetheless, if you aren’t yet part of the target market for this book but you find the ideas interesting, please see Appendix B, Strategic Debt Practice for the Young and Those with Limited Assets, where we discuss how you can use the ideas found here as a frame for your thinking and a guide to your actions.

In general, then, the real sweet spot for making use of the ideas, principles, and practices found in this book is individuals and families who

Have sufficient investible assets.

Want to position their lives so that they can retire in relative comfort.

Are committed to taking care of their family members for the long run regardless of what type of emergency or natural disaster might arrive.

Are interested in minimizing the taxes they pay or in buying a second home or other substantial assets in a much better way.

Assuming that you are part of the audience this book was written for, the next question is how you can most effectively make use of the ideas found here? This brings us to the question of what this book is . . . and what it is not.

Simply put, this book is a general guide. It will show you how to take on and make intelligent use of an optimal amount of Strategic Debt by comprehensively and holistically managing both sides of your balance sheet, that is, both your debts and your assets. What this book is not, however, is a detailed how-to guide for implementing the ideas found here. As already stated in this section, if you are going to move forward with the ideas in this book, you should almost certainly consult with a knowledgeable financial advisor or private banker who can not only help you do things in the best way possible, but also make sure that the ideas found here are actually appropriate for you.

Even the most risk averse individuals—those with the lowest risk tolerances and the least ability to psychologically or financially absorb an unexpected shock—may benefit from the ideas in this book. At a minimum such individuals may want to seriously consider putting an assets-based loan facility, or ABLF, in place, as we’ll get to briefly.

Why might the ideas found here not be appropriate for you even if you fall into the target market defined previously? Well, life is risky, and risk and reward are directly interrelated. So even though we feel that the ideas and practices you’ll find here may tend to systematically reduce your risk and may make you wealthier in the long run in a number of ways, you still have to keep in mind that things could change, these ideas could backfire, or they may not be right for you. To this point, Appendix C is perhaps the most important part of this book—it is an absolute must read. In an earlier draft this appendix was called All of the reasons the ideas in this book can be bad for you.

In addition to this appendix it is important that you read the endnotes in each section where additional risks and topics for discussion with your advisors are identified. In the interest of not having multiple disclaimers and risk factors repeating over and over throughout the book, we have packed a lot of important information about risk into the appendix and endnotes, so please pay close attention to both of them. Accordingly, it is important to know that all of the ideas in this book go together. You can’t just pick up this book and read one part of it. This includes, but is not limited to, the discussion of risks and disclaimers throughout the book. It is all interconnected and it all goes together. The material is presented with a goal of encouraging thoughtful conversation and rigorous debate on the risks and potential benefits of the concepts between you and your advisors.

Not about Buying What You Can’t Afford, but about Strategy

It is essential to know that this book is not about buying things you cannot afford. It is about better ways to finance and pay for the things that you can afford.

Once, after I gave a presentation, some people came up to me afterward and said, So your goal is to have everybody take on a lot of debt?

That is not the objective of this book. Instead, the intent is to express ideas and concepts as to what is optimal, and to encourage people to have a strategy around their debt. Too often people either have way too much debt or they are completely debt averse and have too little debt. There is an optimal middle ground, and the purpose of this book is therefore to set forth a reasonable framework for having an optimal debt strategy.

The Book’s Real Goal

The specific strategies outlined in this book may, in fact, not be optimal for your particular situation. However, the ideas found here should help lay the foundation for you to create your own personalized, optimized debt philosophy. In a certain sense then, the real goal of this particular book is to challenge your basic assumptions and beliefs about the wise and strategic use of debt. Ideally, if the book is successful, it will raise many more questions than it answers, questions you should investigate—with regard to your own situation—with your tax, legal, and financial advisors.

In the eyes of its author, however, this book will be considered a success if by the time you are done reading it, some or all of the following have happened:

You choose to have some debt at all points in your life.

You choose to not aggressively pay down debt in the years leading up to retirement.

You choose to a much greater degree how much tax you will pay the government when you are retired (versus having the government tell you how much tax you need to pay).

You think about and monitor your optimal debt ratio and how it changes over time.

You think about ways to reduce the costs, impact level, and duration of any potential financial distress.

You have more questions than answers.

WHY I WROTE THIS BOOK

Dear Reader,

Throughout the book I occasionally take the liberty of speaking to you more directly and informally. For example, right now I wanted to briefly let you know exactly why I wrote this book in the first place, which is actually quite simple.

I have been teaching the ideas and practices you’ll find here for a number of years now. Excited and even somewhat amazed by the value of debt—how to strategically use one’s Indebted Strengths to be in a much better long-term position—I have been asked many times for a detailed treatment of these ideas.

Well, I looked high and low, both online and offline, and couldn’t find one, so I felt that given the incredible value that people are already finding in these ideas, I would go ahead and take the plunge and do my best to write it all up