Does David Bach Overstate the Power of Leverage?
Golbguru from Money, Matter and More Musings wonders if David Bach’s math is misleading. The author’s simplification of leverage glosses over the finer points, and Golbguru explains how Bach ignores payments on the mortgage one must make. this should be considered part of the cost of investment if you’re talking about a property in which you live. If you’re renting the property to tenants, that cost can be offset by rental income.
A quick calculation using a generic mortgage calculator shows that by the end of five years, a $200,000 mortgage (at a reasonable 6% rate of interest) would cost about $58,000 in interest alone (plus some amount of principal is paid back too … Shouldn’t such costs be taken into account before making claims about doubling money?
More problems with Bach’s logic:
What if you put down only $25,000 instead of $50,000? With his calculation that would give a 200% rate or return. For $10,000 down payment that would be a 500% rate of return. Man..isn’t buying a house really profitable?! At this rate, Bach could easily tell you that if you don’t put anything down you get $50,000 on a $0 investment…
The doubling money argument totally ignores any kind of interest rates (his logic is applicable only when you borrow money at 0% interest rate and don’t make any payments for five years… For someone who is trying to explain potential gains using leverage, this isn’t a good sign. Profitable financial leverage cannot be explained without explaining the difference between the rate imposed on borrowed money and the rate of return that you get when you invest the borrowed money.
Are these arguments legitimate? David Bach in this section of The Automatic Millionaire is trying to sell the idea of homeownership, which has paid off for many people in the last decade or so.
Leverage is a very important concept and is a way to achieve a better return on investment, but this applies best to properties purchased with the intent of leasing to tenants. When you’re making the mortgage payments and paying for home repairs, your property is cash-flow negative and should not be considered a wealth-building investment. You’re hoping that any value appreciation offsets your negative cash flow, which is a losing proposition.