November 17th 2024.
Japan is home to 140 remarkable businesses that have been running for over 500 years, which is twice as long as the oldest companies in the United States. Some of these businesses even claim to have been around since the first millennium. It's truly astounding when you stop and think about it. These businesses have withstood countless challenges, from plagues and wars to natural disasters and economic downturns. And while there isn't one single secret behind their longevity, there is one standout trait that sets them apart: a lack of debt.
A study conducted by the Japan University of Economics Graduate School on Japanese businesses that have been operating for more than 100 years found that more than a quarter of them have enough funds to sustain themselves for at least two years. This is in stark contrast to the United States, where having cash reserves equivalent to two years of expenses would be considered risky by many shareholders. Our culture is focused on growth at any cost, often prioritizing short-term gains over long-term resilience and stability. This mindset often leads businesses to pour their profits back into expansion or take on debt to increase their market share.
To put things into perspective, let's take a look at a big example. The U.S. government spends around $6.5 trillion annually but only brings in about $4.5 trillion in income. This means that the government is borrowing about $6,000 per person to make up for the deficit. It doesn't take a financial expert to see that this is not a sustainable scenario. Any individual or business spending 50% more than they earn will eventually run into trouble. But it's not just about cash flow, it's also about the overall financial picture. The U.S. economy has a gross domestic product of $29 trillion, but the total debt is around $36 trillion. On the other hand, the total value of all U.S. assets is estimated to be around $500 trillion.
Let's break these numbers down even further. When we look at it on a per-person basis, the U.S. can be seen as a business worth $1.3 million with $80,000 in sales and $100,000 in debt. Does this seem out of line? Probably not. This way of thinking helps put debt into perspective.
So how should we approach debt? It's not about avoiding it altogether, but rather finding the right amount and type of debt for your situation. It's important to understand that debt increases your risk level. The more leverage you have, the more vulnerable you are to market fluctuations and unexpected challenges. And as humans, we tend to underestimate our risks.
It's important to remember that debt can amplify both gains and losses. When things are going well, leverage can boost your returns. But when circumstances change, that same leverage can multiply your losses. We are currently seeing this play out in the commercial real estate market, where many investors are struggling because they took on too much debt while their occupancy rates and income have decreased.
When individuals take on debt, they often do so with blind optimism about their future prospects. Debt can be an easy way to "pull your future forward." Want something now but can't afford it? Debt makes it possible. However, life doesn't always go as planned. Unexpected expenses can come up, markets can shift, and problems can arise. That's why it's important to have reserves and be prepared for the unexpected. By planning for the unknown, we can reduce the fear and uncertainty that comes with it.
When it comes to investing, people often make the mistake of using leverage at the wrong time in the investment cycle. When everything is going well and asset prices are rising, leverage can lead to higher returns. But when things take a turn for the worse, leverage can be punishing and even deadly.
The riskier your investment or lifestyle, the more cautious you should be with leverage. If your income or business is unpredictable, it's important to carefully consider your use of debt. On the other hand, if your income is stable and your business is highly predictable, you may be able to use leverage wisely.
As the saying goes, "There are old investors and there are bold investors, but there aren't many old, bold investors." If you want to endure for the long haul, like those Japanese businesses, it's essential to protect your cash reserves and be selective with debt. Resist the urge to "pull the future forward" and be intentional about saving. Your future self and future generations will thank you for it.
Steve Booren is the founder of Prosperion Financial Advisors and a respected author and wealth advisor. He has been recognized as a 2021 Best-in-State Wealth Advisor by Forbes and a 2021 Top Advisor by State by Barron's. This article is not intended as investment advice.
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