INSIDE INVESTOR: Pay down your bad debts ASAP

Not all debts are made equal, so learn how to manage the good with the bad.

What’s that old adage? Never a borrower nor a lender be.

Your grandfather may have instilled that bit of wisdom into you when you were a kid but the last time it was put into practice, it very nearly ended in disaster with the near collapse of the entire financial system.

Back in 2008, nobody wanted to borrow money. And no one had any to lend. International trade ground to a halt, millions of people lost their jobs, their homes and even their families – so much for Pop’s fireside chat.

Debt, in the right dose, is the tonic that maintains a healthy economy and keeps the wheels of industry grinding. When used effectively, it can turbo-charge your wealth creation endeavours. It all depends what you are borrowing for.

In any society there are those who save and those who borrow and the banking system – in theory anyway – is merely the conduit that brings those two groups together. So there is no need to be afraid of debt.

Just like those Hollywood cop shows, there’s good debt and bad debt.

Good debt is when you borrow to invest in an asset that delivers either long-term capital growth or a higher yield than you are paying on the borrowings. For instance, there is no way most of us could save our way into a house in Australia. And most small- to medium-sized businesses are started with some seed capital and a loan.

Then there is the not-so-good debt: not exactly bad because you are still making the repayments. We’re talking about the kind of debt used to fund consumption. A new car perhaps. A spur of the moment, hang the expense trip abroad – that kind of thing.

This is the sort of debt that becomes an albatross. And usually, it is incredibly expensive. So what to do about it? Get rid of it. Or at the very least, refinance it at a cheaper rate.

If you think about it from an investment point of view, where else could you invest your money for a 21 per cent return? Because money saved is money earned. And there are several million Australians with old-style credit cards forking out that kind of interest rate each month, making the minimum required repayment without eroding the debt and in some cases watching it compound.

With deposit rates declining, most investors these days are scouring the market looking for yield when they need look no further than the personal loan or the credit card.