In the financial world, certain principles often defy conventional wisdom, and one of them is the surprising reality about borrowing and depositing money. Generally, we are conditioned to believe that saving money in a bank is the safest and smartest choice. Yet, a closer look at how wealth is built reveals an irony: it is often the borrower, not the depositor, who holds the upper hand in creating substantial wealth. In particular, the rich leverage borrowed money to expand their fortunes, while the middle class often uses borrowed funds for less productive purposes.
This article unpacks the nuanced dynamics of borrowing and depositing, offering insights into why the rich get richer and the middle class struggles to build wealth.
The Irony of Borrowing and Depositing
At first glance, it seems counterintuitive to think that borrowing money could be smarter than saving it. Yet, history and contemporary examples show this to be true. Wealthy individuals and corporations, often hailed as the smartest financial players, strategically borrow money to invest in productive assets. In contrast, middle-class individuals, who diligently deposit their money in savings accounts or fixed deposits (FDs), often fail to see significant returns on their hard-earned money.
Take the example of Mukesh Ambani, India’s richest man. His conglomerate, Reliance Industries, carries a debt of approximately ₹154,478 crore (around $22 billion). Similarly, Tata Motors has a debt of $14 billion, with the entire Tata Group shouldering a total debt of $36 billion. On the surface, this might appear risky. However, this debt is not a burden but a calculated strategy to fuel their business growth, generate higher returns, and build massive wealth.
Middle-Class Borrowing vs. Rich Borrowing
The divergence between the borrowing strategies of the rich and the middle class lies in the purpose and outcome of borrowing:
Middle-Class Borrowing
The middle class typically borrows money for:
- Unproductive Assets: Cars, homes, weddings, or vacations.
- Consumer Spending: Personal loans or credit card debt often go toward fulfilling lifestyle desires rather than generating wealth.
These expenditures may bring short-term satisfaction but do little to improve financial stability. Additionally, interest payments on these loans often surpass the value of the underlying assets over time, further eroding wealth.
Rich Borrowing
In contrast, the wealthy borrow money for:
- Business Expansion: Investing in new projects, machinery, or operations.
- Acquiring Productive Assets: Assets like commercial properties, stocks, or industries that generate a high return on investment (ROI).
- Leveraging Equity: Raising funds from shareholders, effectively borrowing at zero interest.
The crucial difference lies in how borrowed funds are used. Wealthy individuals and corporations channel these funds into ventures that yield returns significantly higher than the cost of borrowing, ensuring profitability even after repaying interest.
Why Depositing Money May Not Build Wealth
For most middle-class individuals, depositing money in banks is seen as a safe and reliable option. However, the returns from savings accounts and fixed deposits rarely outpace inflation, let alone create substantial wealth. Let’s break this down:
1. Savings Accounts and Inflation
Savings accounts offer interest rates of around 4%. After factoring in inflation—which typically hovers around 5%—the real return on savings is often negative. For instance, if you deposit ₹100,000 in a savings account earning 4%, the effective purchasing power of that money diminishes over time due to inflation.
2. Fixed Deposits and Taxation
Fixed deposits (FDs) provide slightly higher returns, usually around 7%. However, these returns are often reduced by:
- Income Tax: Interest earned on FDs is taxable. If you fall into the 20% tax bracket, your effective return decreases by 1.4%, leaving only 5.6%.
- Inflation: With inflation at 5%, the net real return further shrinks to just 0.6%.
This negligible or even negative growth means that money parked in banks does little to grow wealth in the long term.
The Rich: Borrowing to Build Wealth
Wealthy individuals and businesses operate on the principle that money begets money. Borrowed money, when used effectively, becomes a tool to multiply wealth. Here’s how:
1. Investing in High-Return Ventures
Many businesses provide returns of 20% or more on investments. By borrowing at 10–11% interest rates, a rich person or business can still enjoy a significant profit margin after repaying interest.
2. Leveraging Debt Strategically
The rich often raise money through debt or equity, using it to scale operations, acquire competitors, or innovate. This calculated risk ensures that borrowed funds generate returns far exceeding the borrowing costs.
3. Access to Zero-Interest Equity
Raising funds through public share offerings is another key strategy. Shareholders invest capital, effectively lending money at zero interest, while the company grows and generates profits.
Case Study: Mukesh Ambani vs. Anil Ambani
Mukesh Ambani and Anil Ambani, once equally positioned as heirs to the Reliance empire, now stand on opposite ends of the wealth spectrum. While Mukesh has leveraged debt to build a global business empire, Anil’s poor management of borrowed funds led to financial troubles.
The Mukesh Model
- Reliance Industries uses debt to fund expansions in telecom, energy, and retail.
- Returns from these ventures outpace the cost of debt, ensuring profitability.
The Anil Setback
- Anil Ambani’s investments in unprofitable ventures and inability to manage debt led to losses and defaults.
- Poor risk assessment and ineffective management of borrowed money were key factors in his financial decline.
This stark contrast highlights the importance of using borrowed money wisely and strategically.
Why Banks Favor the Rich
Banks are often more willing to lend large sums to the wealthy, and there’s a simple reason for this: risk and reward. Rich borrowers are seen as lower risks because:
- They have diversified income streams.
- They often offer collateral worth more than the loan amount.
- Their ventures are usually high-reward, ensuring timely repayment.
In contrast, middle-class borrowers are riskier as they rely on a single income source and often borrow for depreciating assets.
The Role of Financial Literacy
The ability to use borrowed money effectively hinges on financial literacy. Rich individuals and businesses often have the knowledge and resources to:
- Identify high-return investments.
- Manage risks associated with borrowing.
- Optimize tax benefits through financial planning.
Middle-class individuals, on the other hand, often lack access to such knowledge and may make decisions that hinder wealth creation.
Lessons for Aspiring Borrowers
If you aspire to use borrowed money to build wealth, consider the following:
- Invest in Productive Assets: Use loans to buy assets or start businesses that generate income.
- Understand Risk Management: Borrow only what you can repay, and ensure the ROI exceeds the borrowing cost.
- Enhance Financial Literacy: Learn about investments, markets, and tax-efficient strategies to make informed decisions.
- Plan Long-Term: Wealth creation through borrowing requires sustained effort and disciplined financial management.
The Middle-Class Mindset: Breaking the Cycle
Breaking free from the middle-class cycle of borrowing for consumption and saving at minimal returns requires a shift in mindset:
- Think Like an Investor: Instead of depositing money in low-interest accounts, explore opportunities like mutual funds, stocks, or entrepreneurial ventures.
- Leverage Debt Strategically: Borrow for income-generating purposes rather than depreciating assets.
- Focus on Growth: Prioritize investments that grow your wealth over time rather than satisfy immediate desires.
Conclusion: Becoming Financially Smart
The irony of wealth creation lies in the fact that borrowing, when done strategically, is a more powerful tool than saving. The rich use borrowed money to fuel their empires, generating returns that far outweigh the costs. Meanwhile, middle-class individuals often miss out on wealth-building opportunities by focusing on low-yield savings and consumption-driven borrowing.
To build wealth like the rich, adopt their mindset: see money as a tool, not an end goal. Whether through calculated borrowing, strategic investments, or enhanced financial literacy, the path to financial success lies in understanding how to make money work for you.
As Mukesh Ambani’s example illustrates, it’s not about how much you borrow but how wisely you use it. Smart borrowing, coupled with effective money management, is the key to unlocking financial freedom.
