AMA - How to use gold with debt?
Maheen the Machine asks,
Hello Victor, I trust you are safe and healthy!
I have always had this belief that you collect gold for the day that the dollar loses most of it's value and then you "cash" it in??? Yet, I never hear the experts say to "sell" your gold. They always mention using gold as "insurance" but never go into detail or give examples.
You interviewed Russell Gray and he is amazing. When he was talking about Gold He mentioned using gold with debt. He recently said the same thing on his recent podcast "Golden Opportunity." He states you should "marry" gold with debt. This is unclear to me. I was wondering if you could shed your perspective. Sometimes the same information coming from a different source "penetrates." At least, for my sake let's hope so. HA!
Thank you for what you do. It truly is invaluable!
Thank you Maheen for the kind words and for a great question.
The philosophy that both Russell Gray and I share is that you should have the bulk of your assets in the form of hard assets with intrinsic value instead of paper assets that could carry counter party risk. In order for money to be money it has to perform two functions. It must be a store of value and a means of exchange. The US dollar is a very good means of exchange. A for a store of value, that’s not as clear.
We can debate how much inflation we think we have. But when you look in retrospect there is no question that we have experienced significant inflation over the years. In my lifetime, a cup of coffee has gone from 15 cents to more than two dollars. A gallon of gas has gone from 25 cents to about $2.50 cents, and at times over 3 dollars.
We like to invest in real estate. More importantly, we like to use other people’s money. That is in essence a form of leverage. When you use other people’s money and you retain a portion of the ownership, you get to multiply your rate of return.
But using other people’s money isn’t free. There’s a cost. You either give the lender a rate of return on their money, or you give them a percentage of equity in the project.
If you borrow money, the interest rate that you pay is a function of risk to the lender. If the lender has a lot of security, they’re probably going to be willing to offer you a lower rate. Funds borrowed with a high degree of security in today’s rates might be as low as 3% or 3.5%, depending on the lender.
Unsecured funds could be easily above 12-15%. The cheapest money will be the money that the lender has a guarantee of getting their principal back. Most of the time, borrowers secure their loan against a piece of real estate. The lender ends up having to qualify the borrower, the market and the specific asset. That’s a lot of due diligence.
Let’s look at a specific example. Let’s say that you want to invest in a townhouse that you’re going to hold as a rental. The purchase price is $200,000 and you’re going to borrow 75% from a bank. The remaining 25% is the equity contribution. So you need $50,000 in cash to buy the property. Where are you going to get $50,000?
You decide that you want to borrow the $50,000 that would normally be considered the equity contribution to the purchase. So you go to your friend, the rich lawyer who has tons of cash and you ask to borrow the $50,000. You offer to put, say, $70,000 worth of gold in your friends safety deposit box as collateral. So you pledge 40 ounces of gold.
When the loan gets repaid, you get your 40 ounces of gold back. But a few years have gone by, and your 40 ounces of gold are now worth $100,000. In the meantime, the lawyer charged you 3.5% a year for the loan of $50,000. The property has also gone up in price and instead of selling it for $200,000, you now sell it for $300,000. Your initial investment of $50,000 has now grown by $100,000, and your gold has increased in value by $30,000. You get to keep all of that profit.