3 Things 7-28-25

 Thing One

Good Debt Versus Bad Debt 

Not all debt is created equal and understanding the distinction between good debt and bad debt can be a game-changer for financial success. Good debt is borrowing that creates long-term value or generates returns, such as investing in assets that appreciate or produce income. Bad debt, on the other hand, is borrowing for fleeting wants, like luxury purchases or experiences that don’t contribute to wealth-building. Knowing the difference empowers individuals to make strategic financial decisions, avoiding pitfalls that can lead to financial strain while leveraging opportunities for growth.

Bad debt often stems from borrowing to satisfy immediate desires. For example, consider someone who takes out a $10,000 personal loan at 8% annual interest to fund a lavish vacation. Over five years, they’ll pay approximately $2,432 in interest - and that's if they intentionally take out the loan at a bank instead of putting it on a credit card and potentially paying 3 times that amount. Either way, this debt offers no financial return, only memories that fade and a burden of repayments. Similarly, financing a luxury car that depreciates rapidly—say, losing 20% of its $50,000 value in the first year—means the borrower is left with a depreciating asset and mounting interest, a classic case of bad debt.

Good debt, by contrast, is an investment in future wealth. Take the example of borrowing $200,000 for a rental property with a 4% mortgage rate. If the property generates $1,500 monthly in rent, that’s $18,000 annually, potentially covering the mortgage and yielding profit. Over time, the property may appreciate, say at 3% annually, adding $6,000 to its value in the first year alone (0.03 × $200,000). This debt is “good” because it generates income and builds wealth.

The key difference lies in intent and outcome: borrowing for wants fuels consumption, while borrowing for returns fuels growth. People who don’t understand this distinction often fall into the trap of financing wants—like using credit cards for designer clothes or dining out excessively—racking up high-interest debt with no tangible benefits. For instance, a $5,000 credit card balance at 18% interest, if paid minimally, could take 30 years to clear, costing over $12,000 in interest. This cycle of borrowing for instant gratification can erode financial stability.

Those who grasp the concept of good debt versus bad use borrowing strategically. Consider investing in stocks via a margin loan, where borrowed funds amplify returns. If you borrow $10,000 at 5% interest to buy stocks that yield an 8% annual return, your net gain is 3% (8% - 5%) on the borrowed amount, or $300 annually, minus taxes and fees. This approach requires caution, as markets can be volatile, but it illustrates how borrowing can enhance wealth when tied to assets with growth potential. Education loans can also be good debt if they lead to higher earning potential, like a degree that boosts income by $20,000 annually.  Conversely, they can be very bad if they are used to finance degrees with no (or low) marketability.

The lesson is clear: borrowing isn’t inherently bad, but its purpose matters. By distinguishing between good debt that builds wealth and bad debt that drains it, individuals can make informed choices. A simple rule of thumb is to ask, “Will this debt generate returns or just fleeting satisfaction?” Answering honestly can mean the difference between a cycle of financial stress and a path to prosperity.

Thing Two  

The Dot-Com Bubble Revisited With The AI Runup In Mind

The dot-com bubble, spanning roughly 1995 to 2000, was a period of speculative frenzy driven by the rapid growth of internet-based companies. Investors poured money into dot-com startups, often ignoring traditional valuation metrics like earnings or revenue, fueled by optimism about the internet’s transformative potential. The NASDAQ, heavily weighted with tech stocks, surged 400% from 1995 to its peak in March 2000, with companies like Pets.com and Webvan achieving astronomical valuations despite minimal profits. The S&P 500’s P/E ratio climbed to 44.2 by 1999, far above its historical average of 17.8, reflecting exuberant market sentiment. Interest rates, however, were moderate, with the federal funds rate rising from 5.5% in 1995 to 6.5% by 2000, and 10-year Treasury yields averaging around 6%, creating a backdrop where high valuations faced increasing pressure.

The bubble’s buildup was driven by easy access to capital, with venture capital flooding into startups and IPOs skyrocketing. Media hype and retail investor enthusiasm amplified the mania, as stories of overnight millionaires fueled speculative buying. Anecdotes abound from that time and many an investor can recall owning a dot-com stock that tripled in weeks, only to crash later. By 2000, the bubble burst as many companies failed to deliver profits, and investor confidence waned. The Federal Reserve’s rate hikes to combat inflation tightened monetary conditions, increasing borrowing costs and exposing weak business models. The NASDAQ plummeted 78% from its peak by 2002, and the S&P 500 fell 49%, with the P/E ratio dropping to 21.2 by 2002 as earnings stabilized but stock prices collapsed.

The burst was triggered by a combination of overvaluation and economic tightening. Many dot-coms burned through cash without sustainable revenue, and as funding dried up, bankruptcies surged. High P/E ratios became untenable as earnings failed to materialize, and rising interest rates made safer investments like bonds more attractive. For example, a $10,000 investment in the NASDAQ at its 2000 peak would have been worth just $2,200 by 2002. The S&P 500’s high P/E in 1999 (44.2) was driven by tech stock exuberance, but by 2002, the market corrected to more sustainable levels, reflecting a return to fundamentals.

Today, as of July 25, 2025, the S&P 500’s P/E ratio is 29.48, elevated compared to the historical average but below the dot-com peak. The Shiller CAPE ratio, at 38.8, is high but not as extreme as 1999’s 44.2. Interest rates are lower today, with the federal funds rate at 3.83% and 10-year Treasury yields at 4.2%, compared to 6.5% and 6% in 2000. This suggests a less restrictive monetary environment, supporting higher valuations. However, today’s market is driven by tech giants like Apple and NVIDIA, with stronger fundamentals than many dot-com era firms, though AI-driven optimism echoes the internet hype of the late 1990s.

Comparing the two periods, today’s market shows similarities but also key differences. The dot-com bubble featured speculative investments in unprofitable startups, while today’s high P/E is partly justified by robust earnings growth (10.1% annualized since 2015) and lower interest rates. However, the current CAPE ratio’s elevation (38.8) signals potential overvaluation, as it’s in the top 4% of historical readings. So financial writers are starting to highlight concerns about “AI bubble” risks, with some noting parallels to dot-com exuberance. Unlike 2000, today’s companies have stronger balance sheets, but their valuations assume sustained growth, which could falter if economic conditions shift.

The risk of a bust today depends on several factors. Rising interest rates could pressure valuations, as seen in 2000 when the Fed’s hikes triggered a correction. If the federal funds rate climbs to 5.5%, historical models suggest the S&P 500’s P/E could fall to 21.5, implying a 27% market drop. Economic slowdowns or disappointing earnings, particularly in tech, could also spark a sell-off. However, lower rates and stronger fundamentals provide a buffer compared to 2000. For instance, a tech stock today with a P/E of 30 and 15% earnings growth is less speculative than a dot-com with no profits.

The dot-com bust taught investors the dangers of ignoring fundamentals, and while today’s market isn’t as extreme, caution is warranted. High valuations assume perfect execution, leaving little room for error. A bust isn’t imminent, but risks are rising if earnings falter or rates increase further.  Today’s market, with a P/E of 29.48 and lower rates, is less extreme but still vulnerable. While stronger fundamentals reduce the likelihood of a 2000-style crash, investors should remain vigilant, as elevated valuations and potential rate hikes could signal a correction if growth expectations aren’t met.

Thing Three

Just A Thought  

"Take the risk. If it works out, happiness. If it doesn't, wisdom." - Unknown