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Debt – How do the Rich use debt?

We were taught a bunch of lies about debt. That debt is always: bad, irresponsible, dangerous & even predatory.

The Aramaic words for sin and debt in the bible are the same. In Islam, taking interest is forbidden. Buddha has a framework on money called Buddhist Dhamma which says, “Money that originates as interest-bearing, centralized, privatized debt is harmful, unethical, and delusional.”

So, our conflict with debt runs deep.

Perhaps all those things CAN be true, in fact, there are echoes of what we are going to talk about today that are incredibly dangerous and just led to massive bankruptcies.

But when you actually understand debt, it can be a lever that lifts the world. Removing the emotion from it and inserting the efficacy is our goal today.

How do the Rich use debt?

In one sentence: Avoid taxes, take loans.

The rich such as Elon Musk, Larry Ellison, and Bill Gates, all borrow against their stock to get $ and avoid capital gains tax. These types of loans are called Securities-based Loans or stock collateralization. By the way, I think finance peeps just like adding vowels to words to charge more, eh?

How does this work?

Well – IF you hold sizable shares of a listed company, you can often do the same.

Musk for instance has an evergreen credit facility for $90Billion+ where he uses this exact strategy. The rich like debt, because you don’t get taxed as income or as capital gains on loans. So they essentially create loans to themselves through their brokerage accounts:

Let’s Break it Down:

Let’s say Musk has 175 million Tesla shares with Merrill Lynch #NBD. He calls up his banker & pledges (puts up as collateral aka the bank could take them if he defaults) 88.3 million Tesla shares.

That’s 36% of his stake which gives him $94 billion.

Now he has $94B to spend without having to sell a single share.

How common is this?

Over 32 billionaires in the Forbes 400 have this type of line of credit that we can track. Of all Fortune 500 companies that are more than 560 executive officers use stock loans, and 5%+ large shareholders currently pledge collateral.

The average pledge is $427M. Pennies really. While the total amount tracked and pledged from this group is $239B, according to a report from Audit Analytics.

How do you repay the loan without selling?

Aren’t you just kicking the can having to eventually pay? Maybe. Or your stock keeps growing and covers your debt service. If you’re getting a return of 10% over time and you’re paying less interest than that you are ahead. Or your dividends pay for the interest.

DISCLAIMER: Don’t Be an Idiot

Downsides? They’re big.

The worst-case scenario: Lose it all

The stock goes down, you need more stock or more cash to compensate, you don’t have enough money, and you lose everything.

Opportunity cost:

Or your stock could be locked up unable to sell until your loan is repaid and you miss out on a great deal.

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