Are You Optimal?

Finance geeks already know what an "optimal capital structure" is. And, we have to admit, we're among them.

Capital structure is the mix of a company's debt and equity—it's how a firm finances its overall operations and growth by using different sources of funds. Most people only think of businesses in this way. We (the finance geeks) like to look at individuals and governments in this light, too.

Everyone fears debt—it's risky and it hangs over your head…and one day you'll have to pay it back! But fear shouldn't dictate your decisions on leverage. Debt is great—it's one of the most important and useful mechanisms ever conceived in developing capital markets, growing economies, and allowing individuals to achieve their goals.

The important thing is not how much debt you have, but whether you're generating a positive return net of the costs of your debt. This is not a business thing, this is a life thing. People take on debt to go to college to get a better job and generate a higher income than they otherwise would—making the assumption of debt indispensable to their goals. The same is true for mortgages and all sorts of other things.

As a matter of fact, the US as a whole consistently generates a positive return on its debt. We even believe it would be more profitable if the US took on more! More mind-bending still, it's been shown that stocks perform better in times of big budget deficits (increasing leverage), and not as well when we've got budget surpluses (reducing leverage).

Like any company, each person and government has an optimal capital structure. Maybe it's time to get a little geeky and ask yourself how optimal you really are.