Why Smart Borrowing Can Be Smarter Than Saving: Lessons from the Rich

It may seem ironical, but the world of finance often works in paradoxes. A common notion is that depositing money in a bank signifies financial prudence, while borrowing money indicates financial instability. However, this conventional wisdom is often turned on its head by the very people who are financially successful—the rich. The reality is that, generally speaking, smart individuals are the ones who borrow money, not the ones who deposit it in banks. Rich individuals borrow money strategically, and this approach often contributes to their wealth.

The Borrowing Habits of the Rich vs. the Middle Class

The irony becomes clearer when we examine the stark contrast between the borrowing habits of the middle class and the wealthy. A middle-class person typically borrows money for unproductive or less-productive assets—such as purchasing a car, building a house, or funding a wedding. These assets either depreciate over time or fail to generate sufficient financial returns. In contrast, a rich person borrows money to invest in productive assets, such as businesses, infrastructure, or equity markets. These investments yield returns that far exceed the cost of borrowing, enabling the borrower to generate significant profits.

This dynamic underscores a critical difference between the financial mindset of the middle class and the wealthy. Middle-class individuals tend to save their money in banks, where they earn modest interest rates. In contrast, the wealthy borrow money to amplify their returns, understanding that money has the potential to generate more money when utilized effectively.

Real-Life Examples: Mukesh Ambani and Tata Group

Consider the case of Mukesh Ambani, India’s richest man and chairman of Reliance Industries. His company operates with a debt of approximately ₹154,478 crore (about $22 billion). Tata Motors, another industrial giant, holds a debt of roughly $14 billion, while the broader Tata Group’s total debt amounts to $36 billion. These figures are staggering, but they are not alarming. Why? Because these businesses have leveraged their borrowings to create value that far exceeds their liabilities.

The rich understand how to use borrowed money as a tool to scale operations, enter new markets, and innovate. By borrowing at a manageable interest rate and investing in high-return ventures, they effectively use other people’s money to grow their wealth. This strategy requires two essential skills: the ability to identify productive investment opportunities and the capacity to manage borrowed funds over the long term.

The Middle-Class Trap: Savings and Inflation

In contrast, the financial practices of the middle class often result in negligible or even negative real returns. Most middle-class individuals deposit their savings in banks, either in savings accounts or fixed deposits (FDs). While savings accounts offer interest rates of around 4%, fixed deposits provide slightly higher rates of about 7%. At first glance, these rates might seem reasonable. However, once inflation and taxes are factored in, the picture changes dramatically.

For instance, if inflation is at 5% and the individual is in the 20% income tax slab, the real return from a fixed deposit yielding 7% interest becomes just 0.6%. Here’s the math:

1. The gross return is 7%.
2. After deducting 1.4% (20% of 7%) as income tax, the net return is 5.6%.
3. Subtract the inflation rate of 5%, and the real return is a meager 0.6%.

In savings accounts, the situation is even worse. With interest rates around 4%, real returns are often negative after adjusting for inflation and taxes. Essentially, middle-class savers are losing purchasing power, despite diligently setting aside their money.

The Power of Borrowing: Why the Rich Borrow

Rich individuals approach money differently. They recognize that the cost of borrowing—often around 10-11% for businesses—can be outweighed by the potential returns on investment. Many industries and businesses offer returns of 20% or more on invested capital. By borrowing at 10% and earning 20%, the wealthy create a profit margin of 10% after accounting for interest costs.

Additionally, rich individuals have another powerful tool at their disposal: equity financing. By raising money from the public through shares, they effectively acquire capital at a 0% interest rate. Shareholders receive dividends or returns based on the company’s performance, but there is no fixed interest obligation. This dual approach—borrowing from banks and raising equity—provides the financial leverage necessary to operate and expand large business empires.

The Key to Smart Borrowing: Productive Investments

Borrowing money is not inherently good or bad; its value lies in how it is used. To emulate the success of wealthy individuals, one must adhere to two principles:

1. Invest in Productive Assets: Borrowed money should be directed toward ventures or assets that generate returns exceeding the cost of borrowing. Whether it’s starting a business, acquiring revenue-generating property, or investing in technology, the focus should always be on productivity.
2. Master Financial Management: Effective management of borrowed funds is crucial. This involves planning, forecasting, and adapting to market changes. Poor financial management can turn borrowed money into a liability rather than an asset. For instance, the financial trajectories of Mukesh Ambani and his brother Anil Ambani illustrate this point vividly. Mukesh’s ability to manage debt has propelled him to unparalleled success, while Anil’s financial mismanagement has led to significant setbacks.

The Cost of Ignoring Financial Literacy

The primary reason why middle-class individuals shy away from borrowing to invest is a lack of financial literacy. Many people are unaware of how to use borrowed funds to create wealth. Instead, they focus on minimizing debt and preserving their savings, unaware of the opportunity cost. This cautious approach might provide a sense of security but rarely leads to significant wealth accumulation.

Furthermore, the middle class often underestimates the impact of inflation on their savings. Inflation erodes the purchasing power of money, meaning that savings left idle in a bank account are effectively shrinking in value over time. By contrast, the wealthy use borrowed money as a hedge against inflation, ensuring that their investments grow at a rate faster than the decline in money’s value.

Building Wealth: Lessons for Aspiring Borrowers

If you aspire to leverage borrowed money like the wealthy, here are some key takeaways:

1. Understand the Cost of Debt: Borrowing money comes with an interest cost, which must be carefully managed. Ensure that your returns on investment are significantly higher than the interest rate.
2. Educate Yourself: Financial literacy is the foundation of smart borrowing. Learn about different investment opportunities, risk management, and financial planning.
3. Start Small: If borrowing large sums feels daunting, start with a modest amount and invest it in a low-risk, high-return venture. Gradually increase your borrowing as you gain confidence and expertise.
4. Seek Professional Advice: Consult financial advisors or mentors who can guide you in making informed decisions about borrowing and investing.
5. Avoid Unproductive Debt: Resist the temptation to borrow money for non-essential or depreciating assets. Focus on investments that generate income or appreciate in value.

Conclusion: The Borrower’s Advantage

In the world of finance, the adage “money begets money” holds true. Rich individuals borrow money not because they lack funds but because they understand the power of leverage. By using borrowed money to create wealth, they achieve financial success far beyond what could be accomplished through saving alone.

For the middle class, the challenge lies in breaking free from traditional financial habits and adopting a more entrepreneurial mindset. By learning to borrow wisely and invest strategically, they too can unlock the potential of borrowed capital and move closer to financial independence.

In the words of financial experts, “It’s not about how much money you have; it’s about how you use it.” Borrow smartly, invest wisely, and watch your wealth grow. After all, the difference between being a Mukesh Ambani and an Anil Ambani often boils down to how effectively one manages borrowed money.

Would you rather be the one depositing money in the bank or the one borrowing it to build an empire? The choice is yours.