CHAPTER 4
The Gift of Enough
DEBT AND FINANCIAL FREEDOM
Years of success and prosperity in our economy have created a consumer-based society. We are no longer worried about our physical or financial survival; therefore, we have undertaken a new challenge. We have embraced the illusive challenge of accumulating more. Please understand that there is absolutely nothing wrong with enjoying material possessions. It is important, however, to draw a distinction between the possessions we have and those possessions that have us.
Timeless Truth
If your goal is to acquire a certain standard of living or lifestyle for you and your family or for your future security, this is admirable; however, if it is your burning desire to keep up with the image portrayed by the commercials on television or in the glamour magazines, you have been afflicted with the dreaded disease called more.
More is a disease that feeds upon itself. As we rush about aimlessly trying to accumulate more, we become aware of an even greater number of things we don’t have and must obtain. Instead of seeking the impossible goal of reaching more, we should, instead, seek the internal goal called enough.
Ironically, we can find people who are literally billionaires who have long ago lost count of all of their possessions; however, these people are still driven by that circular quest for more. On the other hand, there are people of seemingly modest means who have attained the state of enough. They no longer judge themselves based on what they have, but instead on who they are. They have come to the conclusion that it is more important to be someone special than to have a vast accumulation of possessions. They understand that it is not important to be a “human having.” It is only important to arrive as a “human being.”
In the final analysis, reaching the state of enough will give you the confidence and peace of mind to be an even better person who will attract more success, often providing the means to acquire the tangible possessions that have become such an addiction in our society. Focus on who you are, and allow what you have to become a result of your personal success.
Jim Stovall
“Freeeeee-dooooom!” Mel Gibson played William Wallace in the 1995 Academy Award-winning movie, Braveheart, set in Scotland in the year 1280 A.D. I hate to spoil the ending if you’ve never seen it, but Wallace does eventually get caught and is recommended to be “purified by pain,” dying at the hands of a British torturer and executioner. After putting Wallace through a goodly number of physical atrocities, the executioner gives him a final chance to pledge his allegiance to the brutal King Edward “The Longshanks” who is, incidentally, on his death bed as well (and conveniently within earshot). Instead of begging for mercy, Wallace yells out “Freedom!” at the top of his lungs, yanking every ounce of satisfaction away from the dying king.
Financial freedom and flexibility is what I want for you. Despite the multimillion-dollar line-up of clever commercials from credit card companies that lure your business with the hollow promise of financial freedom and flexibility, it is the overutilization of their products that will most assuredly lead to financial bondage and submission. Financial freedom and flexibility is found in low or no debt and plenty of liquid savings. And, since your run-of-the-mill savings account doesn’t offer a whole lot of sex appeal, I hereby submit for your consideration the “Freedom Fund” or your “Braveheart Account,” whatever you need to call that savings account to remember its purpose.
The inverse of freedom is bondage; the inverse of savings is debt. The two are inextricably intertwined. One is the problem and the other the solution. Before you flip to the next chapter because you don’t have an ounce of credit card debt, you’re comfortable with your level of savings, and you’ve never missed a mortgage payment, don’t leave us just yet. We will be discussing the insidious enslavement of revolving debt, but we’re also going to tackle the question of whether there is such a thing as “good debt.” And even if you don’t have any debt—not even a mortgage—I still want you to read this chapter if only to give you educational material for those under your mentorship.
Ultimate Advice
[Americans] are borrowing and spending as if there were no tomorrow, and they are investing as if there were no yesterday.
Bill Bonner And Addison Wiggin
Our current financial crisis may be the best thing that ever happened to us financially. It’s hard for me to write that, and it may also be hard to read it if you’re one of the many who have suffered in this time; but the primary lesson American citizens, American financial institutions, American businesses, and (hopefully) the American government have learned in recent years is that we must not borrow and spend as if there were no tomorrow and invest as if there were no yesterday. If you are a young professional, I hope you will internalize this truth and allow it to be a reminder when you’re tempted to fall into bad spending and saving habits. If you’re close to retirement, the pain will be greater and the outlook more grim, but you also have a way to benefit from this difficult lesson, if only to give strong encouragement to your children and grandchildren not to fall into the same trap.
What brought us to this point? Affluenza. As reported by PBS in a special that aired long enough ago that its web site still offers to sell you a copy on VHS, Affluenza is “the bloated, sluggish, and unfulfilled feeling that results from efforts to keep up with the Joneses. An epidemic of stress, overwork, waste, and indebtedness caused by dogged pursuit of the American Dream. An unsustainable addiction to economic growth.” I’m guilty. Are you?
Pat Goodman, a close friend and mentor of mine, has a number of memorable maxims I wish I’d come up with. He encourages me to live a life of purpose when reminding me, “You go no place by accident.” But it’s the following prophetic truism of Pat’s that seems to ring especially true when taking on Affluenza-driven debt: “You not only have to want what you want; you have to want what your wants lead to.”
You not only have to want that bigger house; you have to want to ruin your credit in foreclosure if your adjustable rate mortgage sends your mortgage rate to the moon. You not only have to want to spend all of your discretionary income today instead of saving for emergencies; you have to want to settle for that job you don’t love when you lose the job you did because you didn’t have the emergency reserves to hold out for the right position. You not only have to want to buy that flat screen TV on your zero percent credit card for a year; you have to want to pay the 21 percent retroactive interest if you haven’t paid it off in full on the 366th day. You not only have to want to take on debt providing immediate gratification; you have to want to deal with all of debt’s friends—interest payments, loss of freedom, collections, foreclosure, and bankruptcy.
It is important now to remember a fundamental theme of this book introduced in the very first chapter and illustrated throughout. Money is not the root of all evil. It’s a neutral tool to facilitate the furtherance of relationships. The use of debt and the business of lending are not inherently evil either, but I struggle to write that they are purely neutral. Debt is always shadowed by an element of bondage because the indebted is contractually obligated and beholden to someone or something. Wise utilization of debt can be used to positive economic benefit, without question, but the elimination of debt grants an uncommon level of peace that is profound and prolonged. I can account for its validity from the stories of numerous clients, several of whom reported that the sense of unburdening they felt upon the dissolution of that final piece of debt—possibly even a small mortgage with a good interest rate—was visceral and lasting. Whether you’ve paid off your debt or not, don’t you long to do so?
Ultimate Advice
The borrower is servant to the lender.
Proverbs 22:7
But what advice do many economists and politicians give us at this time, even as we are on the verge of converting the financial stress and pain we’ve felt to the resolute practice of living within our means? “Buy real estate! Buy cars! Buy computers and TVs! Spend, spend, spend!” It frustrates me horribly to hear economists and financial commentators on the radio or television suggest that the only path back to economic prosperity is for consumers to “get back out there spending.” How could they be so shortsighted to suggest that the best course forward is for more of what got us in trouble in the first place? A newly sober alcoholic will end his painful withdrawal symptoms with the rapid consumption of a bottle of Jack Daniels, but it most assuredly will not aid him in the path to freedom.
Most of those who are indebted do not actually have a pathological debt problem. It’s a cash flow problem, a budgeting problem, and most often, a savings problem. In Chapter 3, we talked a lot about how to put in place a great cash flow and budgeting system. We also mentioned the importance of margin in the management of your personal finances, and there is no better example of margin than the mythical emergency savings. Emergency savings is that financial elephant in the room. Financial writers and planners have adequately educated everyone on the need, but much like flossing your teeth, everyone knows you’re supposed to do it, but no one does it!
No one does it, that is, until they feel some pain. That is how I can suggest this current crisis is a good thing for us, on both the personal and institutional levels. It gives us the opportunity to see precisely how painful it can be to find ourselves on the wrong side of the debt/savings ratio. At this moment, the market “only” fell 50 percent (spanning the end of 2008 and the beginning of 2009), and unemployment is “only” around 10 percent. I say “only” here because during the Great Depression, those amounts were 90 percent and 25 percent, respectively. While later generations of Americans are chided for their short-term memories, that was not a problem for those in the Greatest Generation.
A dear friend of mine, now in her late 80s, lived in a time in which she felt and saw the direct impact of the Great Depression. She is a widow who has lived most of her life in a modest Baltimore row home. She never, throughout her working years, took a vacation. Never. She worked well past retirement age, even as defined by Social Security. She has no debt—of course—and although her net worth is in the millions, she has never stopped saving. The vast majority of her savings are in investment vehicles that are guaranteed by the full faith and credit of the United States government, and she invested dribs and drabs in various banks within walking distance because she didn’t trust the solvency of any one. Did I mention that she never even took a vacation?!
Her story is not uncommon. I’ve met with multiple Depression Babies who literally had cash buried in the backyard in Mason jars to guard against the insolvency of the American financial system. We may be able to look at their situation now and say, “That’s crazy!” or “That’s ridiculous!” but I assure you that if you had lived in a time where you lost 90 percent of your nest egg and one in four of your friends were out of a job, you may see financial security a bit differently.
So what have you heard about emergency reserves? Rules of thumb range from one to 12 months, and no one seems to know what they need. And, is it three months of expenses or income? This and most rules of thumb in personal finance are oversimplifications often tossed aside because of their impersonal feel. We’ll tell you what you should have for your emergency reserves (and why you should have it) and rely on your intimate knowledge of your own finances to help dictate your ultimate course.
The three factors of which to be cognizant when determining your personal rule of thumb for emergency reserves are the following:
1. The number of sources of family income: whether or not a household is reliant on one or two income earners.
2. The nature of business supporting those sources: a tenured professor simply has more job security than a freelance artist.
3. The variability in those income sources: whether the income is derived from a pure salary or based largely or completely on bonuses and/or commissions.
I do suggest you calculate your emergency savings in denominations of months, as we’re generally estimating the severity or length of a job loss or income reduction. To that end, maintaining whatever number of months of your expenses (not your income) is sufficient. While most people need the vast majority of their income to cover their expenses, rendering this debate largely moot, there are those who make more than they spend and save. If someone is making $13,000 per month and “using” only $6,500, there is simply no need for them to warehouse twice the cash they need in a liquid account with minimal opportunity for growth. Consider the following matrix for monthly savings:
- 3 months’ expenses for dual-income household with salaried workers in stable jobs and industries.
- 4–6 months’ expenses for single-income household with salaried worker in stable job and industry.
- 6 months’ expenses for dual-income household with variable incomes in stable jobs and industries.
- 7–9 months’ expenses for single-income household with variable income in stable job and industry or salaried worker in unstable industry.
- 9–12 months’ expenses for dual- or single-income household with variable income in stable job and/or cyclical or volatile industry.
- 12 months’ expenses or more for self-employed and business owners.
I bet no one has ever told you why some multiple of a 30-day period is used to create these rules, so let’s examine that. In our three-month example, if someone lives in a dual-income household with both income earners working in a stable industry, probability would suggest that it is unlikely either would lose his or her job; but if one of them did, it could take up to a few months to shine up the resume and find a position meeting his or her expectations. They should have three months of their combined income, though, just in case they run into one of those financial perfect storms in which a job loss is followed by a leaky roof and a new transmission in the minivan. The additional months tacked on to other households reflects their household potential for financial risk.
The location of the above savings is generically suggested only to be in liquid, FDIC-protected savings. This is a good rule of thumb, but can be overly conservative for balances that are especially large. For example, the business owner making $250,000 per year will ideally have $250,000 of liquid savings at his or her disposal, but as long as the business is well established and in a stable industry, the entirety of the savings should not be in a low-interest-bearing savings account. A healthy portion should be in pure cash with the remainder in a conservative, liquid investment portfolio balanced between cash and CDs as well as an appropriate (for the economic times) balance of bond and even stock exposure. This will be discussed further in our investing chapter.
Ultimate Advice
In The Ultimate Gift, Jason Stevens is given the assignment to write a “Golden List”—a catalogue of 10 things for which he is thankful. It sounds like a simple assignment, but the idea is for it to become an ingrained habit engendering a spirit of gratitude in lieu of want. Our debt epidemic is less of a money problem and more of an outward expression of discontentment.
Debt, we’ve established, is something you are obligated to pay another person. Someone has granted you a credit—given you goods or services for the promise of future payment—or has loaned you cash to spend on whatever you choose (a personal loan) or has loaned you money against another asset like a car, boat, or house (a collateralized loan). These consumer loans can be revolving debt or installment debt. An auto loan or mortgage is an example of installment debt. The bank loans you $25,250 to buy a car at seven percent and requires you to make payments of $500 per month for 60 installments (five years). Revolving debt has no set timetable for repayment and allows you to borrow perpetually up to a maximum line of credit. Credit cards and home equity lines of credit (HELOC) are examples of revolving debt.
How then do we differentiate between good debt and bad debt? I’m tempted to suggest bad debt is any kind that requires you to owe money to someone else—all of it! I do believe everyone should be working in the direction of having no debt, and I can better segregate the various types of debt as bad debt and better debt. Bad debt is any kind of debt on a depreciating asset—assets that lose value over time. This is furniture, computers, stereo equipment, clothes, jewelry, boats, motorcycles, and yes—this includes automobiles.
Dave Ramsey, one of the foremost voices on the subject of consumer debt, has no time for pleasantries, sympathy, or nuance. Here’s what he has to say about automobile debt in his bestseller, The Total Money Makeover1. “Taking on a car payment is one of the dumbest things people do to destroy their chances of building wealth.” But you suggest, “Dave, I can get a car these days at MSRP with a zero percent rate of interest.” He responds, “A new car loses 60 percent of its value in the first four years; that isn’t zero percent.” If you, like Steve Martin in the Saturday Night Live skit, “Don’t Buy Stuff You Cannot Afford,” (you can find a link to this segment on www.ultimatefinancialplan.com) have no idea how one would purchase something without using credit, here’s what Mr. Ramsey has to suggest regarding an auto purchase:
If you put $464 [the average car payment] per month in a cookie jar for just 10 months, you have more than $4,000 for a cash car. I am not suggesting you drive a $4,000 car your whole life, but that is how you start without debt. Then you can save the same amount again and trade up to an $8,000 car 10 months later and up to a $12,000 car 10 months after that. In just 30 months, or two and a half years, you can drive a paid-for $12,000 car, never having made a payment, and never have to make payments again.
You say, “But I can’t buy the car I want for $12,000!” It is true that some people simply don’t care about the type of car they drive. They see it as the depreciating asset that takes them from one place to another. Warren Buffett, one of the world’s richest men, is known for showing frugality in the area of automobiles. I, personally, am not one of those people. I have to subvert every materialistic fiber in my being when powerful sports cars drive by—especially German ones. If it weren’t for my father—the electrical engineer who fits the beloved stereotype for frugality—and his insistence that I drive cheap beater cars as I grew up, I would’ve made a foolish mistake many years ago that would have had a significant impact on me today. Let me explain.
My first car was a Plymouth Horizon worth $4,000. “The Horizon,” as it was known by my buddies (accompanied with a sweeping arm gesture illustrating the horizon), was not a cool car. But, it got the job done, and may have even played a role in saving my life, as it was the car in which I had a near-fatal car accident. It ended up at a junkyard where the owner said he couldn’t believe the driver actually lived. After my accident, some family friends took pity and gave me a 1981 Volkswagen Rabbit. One day, gears two and four of the manual five-speed transmission ceased to function. I drove it to the junkyard using only gears one, three, and five (can you picture the sights and sounds of that drive?). My parents again helped me out and fronted me $1,200 to replace the deceased Rabbit with an ailing Pontiac Fiero (not to be confused with a Ferrari, the Fiero was the two-seater death trap known for its fiberglass body and unexplainable spontaneous combustion).
In my first successful capital transaction, I sold the Fiero for $1,400 to someone else who mistook it for cool and bought a 1980 Volkswagen Scirocco for $900, putting the profit into stereo equipment likely worth more than the vehicle. While I still think that is a classic vehicle generically speaking, mine was painted in the same color scheme as the owner’s Winnebago, behind which it was towed. Again, not particularly cool. After that car gasped its dying breath in the parking lot of the same junkyard that was the final resting place for my Horizon and Rabbit, I purchased a Honda Civic for $4,000. I did need a vehicle to get to and from school and work and wasn’t wise enough to save up the money to purchase it in cash, so my Dad cosigned on a short-term auto loan with our credit union.
Days after my wife and I were married, her financially frugal husband asked her to sell her beautiful, paid-for Volvo S70 T-5. Unlike most Volvos, this thing was a true sports car with a turbo enhanced engine. But, our matrimony brought with it a small amount of bad debt, so I twisted my wife’s arm to sell the Volvo and buy another Volkswagen (this time stepping up into the “big time” with a Jetta) for $12,000 and use the profit to pay off our remaining credit card debt. At that point, we had no bad debt. After the Jetta hit 180,000 miles and began to show signs of its looming demise, I bought, for the first time ever, a car that I really wanted. It’s a BMW 3 Series. It looks like it is worth a fortune, but I bought it used from a great friend who I knew took fantastic care of it. With around 70,000 miles already on the car, I got it for under $10,000. Both of our family’s cars now have over 100,000 miles on them, but they are makes and models that should easily go over 200,000.
Let me be clear on this point. There’s nothing wrong, immoral, or unethical about buying new or expensive vehicles; but when we get caught up in the Affluenza plight, we convince ourselves we need that minivan with the leather swivel seats and DVD players that fold down for each row because our family has grown. Once obligated to that monthly payment on a depreciating asset, we also lose our financial flexibility. Several years back, my wife and I took what would have been our car payment money—$500 per month—and purchased one-half of a lake cabin and property with a family member. If we had a brand new hybrid Toyota Camry instead, we may have helped reduce carbon emissions, but we’d not have been able to enjoy the environment as much as we do at the lake.
Carmen Wong Ulrich is a television and print journalist and the author of The Real Cost of Living2 and Generation Debt3. Having worked with Carmen on her personal finance show on CNBC, I knew that the topic of debt is one that is very personal for her. She offered to share some of her personal experience with us.
Carmen got herself in and out of debt—twice. She didn’t come from a family of significant means, so she and her mom worked waiting tables to put Carmen through her undergraduate education. She emerged with her degree, but still with $40,000 in student loan debt and another $2,000 in credit card debt. Upon graduating, she acknowledges she felt entitled to get some decent interview outfits and furniture for her apartment. It is in some of those instances she feels she crossed the line. Carmen began to succeed professionally and shortly thereafter eliminated her bad debt.
Then came round two. Like many young people, Carmen got swept up in a relationship that ended after a two-month marriage. She was in grad school at the time, and getting through the divorce and staying on track with her education took a significant emotional and financial toll on her. She added, “Divorce always puts you in some form of debt,” emotionally and/or financially.
The accrual and repayment of debt has significant emotional and financial components. Ulrich refers to her time with substantial debt as a period in her life when she felt imprisoned. But once she mastered the emotions, it was her financial acumen and discipline that enabled her to rid herself of bad debt. The first and most important step in debt elimination is the twofold decision you make to eliminate your credit cards as a purchase option and divert discretionary cash flow to debt repayment acceleration.
It’s normally not blatant, wasteful spending that allows credit card debt to accrue; it’s the aggregation of a number of individual decisions, each of which on its own merit appears benign. Some, however, do develop an addiction to excessive spending and debt itself. In these situations, you and your financial planner should be augmented by a counselor or psychologist to help delve deeper into your past to explain the actions of the present and plot a successful course for the future.
Dave Ramsey acknowledges he’s not the first to suggest it, but he might be the most ardent promoter of the “Debt Snowball” technique for getting out of debt. In his version of the technique, you list out each of your credit cards and respective balances. Make nothing more than minimum payments on all of your cards, except one. Divert any and all discretionary income you have toward the repayment of that single card. Then, once it’s paid off, apply all of that overpayment to your next card, then the next, and so on.
Ramsey suggests disregarding the interest rates and paying the cards down starting from the smallest balance to the largest, allowing for the “moral victory” of paying a few cards off early to get your snowball rolling. I recognize the psychological benefit of that technique, but the number cruncher in me computes that from a purely financial perspective, you’ll save more money by paying the cards off in order of highest to lowest interest rates. If you need a swift kick in the pants to get things moving, go through Dave Ramsey’s Total Money Makeover and follow his debt elimination plan. If you’ve already resolved to get rid of your debt and have the discretionary income to do it, consider getting your snowball rolling starting with the highest interest rate.
Economic Bias Alert!
Most bankers and credit card executives aren’t bad people, but they do have a conflict of interest to keep you in debt, which is undoubtedly bad for you and your finances. Credit card companies do make money in ways other than charging absurd interest rates. I spoke with Odysseas Papadimitriou, formerly the senior marketing director at Capital One credit card company, now the CEO and founder of Card Hub, a web site designed to help consumers choose the best credit card for them. He told me that credit card companies could survive even if every borrower paid off his or her credit cards every month, because they charge the merchants 2.5−4 percent of every credit card transaction.
But have no doubt that credit card companies also seek a profit in the rates they charge and the minimum payment cycles offered to borrowers. Although it has improved as a result of new credit card legislation, making the minimum payment on most credit card balances with most credit card companies has historically been a joke, stretching payment schedules on balances in the thousands out over decades.
Carmen Wong Ulrich told me of an analysis she did on her CNBC show, “On the Money,” in which a credit card borrower owed $25,000 across seven different cards. If she kept making the cards’ minimum payments, she would pay them off in 15 years and 10 months. However, if she added an additional $200 to the payment on her card with the highest interest rate, all the cards would be paid off in two years and one month!
Lenders, and especially credit card companies, have an economic bias to keep you in debt. And, as Mr. Papadimitriou, the former credit card executive, told me, “Borrowers must avoid the trap of consumer entitlement and always be working toward a debt-free end.”
If bad debt is any debt on a depreciating asset, what are permissible forms of better debt? Debt can be wisely used in the purchase of appreciating assets, but with varying degrees of risk. Wise investors will seek to reduce the risk of borrowing to the greatest degree possible. A business should be an appreciating asset. An education should be an appreciating asset—for the student, not the parents—and as we’ll discuss further in our chapter on education planning, one must not assume that every expense made in the pursuit of education is wisely spent.
A house is an appreciating asset over a long stretch of time and the best example of better debt. We relearned a lesson in the last several years that real estate can and does lose money, and additionally that real estate will likely not be increasing in value with double-digit growth. When it does, you can be quite sure it will eventually retreat back toward a more normal growth rate nominally above inflation and not out of reach of income earners. To reduce the debt risk of a home purchase, you should make a meaningful down payment (20 percent or more, ideally, although it can be done responsibly with less money down) and lock in your mortgage to a fixed rate. Although in some environments an adjustable rate mortgage (ARM) can work to your advantage, the increase in risk is not worth the potential benefit for most homeowners.
You’ve no doubt heard the term leverage used to describe debt. Two dollars in your pocket can buy precisely two dollars worth of goods or services. But what if I was willing to match your two with an additional eight to make a total of 10? That would add leverage to your investment, giving you more money to spend. If you spent that money wisely, and it doubled in value—to $20—then you could pay me back the eight that I loaned you and keep the 12 for yourself. On an investment of two dollars, that is a 600 percent rate of return! Not bad.
What if the investment didn’t pan out? What if you put up two, I put up eight, and the $10 investment lost 50 percent and was sold for five dollars? You’ve lost your two and you still owe me eight, so you need to find another three bucks to supplement the remaining investment of five just to pay me back. In that case, the use of leverage resulted in a 250 percent loss!
You might think I’m exaggerating to make a point here, but the percentages used above are carbon replicas of what happened to a large number of homeowners in the last several years. In the last decade, it was not at all uncommon to own a piece of real estate that would have doubled in price. In that example, if you put 20 percent down on the house—the old rule of thumb—you could have seen that 600 percent rate of return, although it would have been diminished by the interest paid on the mortgage (your leverage) and the transaction costs of buying and selling the property.
Many neighborhoods across the country have seen the value of their real estate cut in half within the last several years. If in 2007 you purchased a house for $300,000 in Cape Coral, Florida, one of the highest flying real estate markets during the housing boom, it is all too realistic to expect that your home is now worth $150,000. So, if you put down $60,000 (20 percent) and the bank pitched in the other $240,000, you would lose all of your investment and still be writing a check to the bank for $90,000!
Now comes the answer to the age-old question, “Should I work to pay off my mortgage as soon as possible or maintain a mortgage indefinitely for the tax breaks and invest the money that I’d use to pay off my mortgage?” It seems that most financial advisors, accountants, bankers, and economists agree that a wisely used mortgage is always a good thing. I disagree. In order to understand my disagreement, you must understand how I look at every financial decision.
In all financial decisions, there are two genres of thought to consider: economic and emotional. The economic considerations are quantifiable and available for analysis. The emotional are difficult to quantify, and in many financial circles are considered worthless or insignificant. That’s rubbish! Economic considerations are far from meaningless, but the point of most financial decisions is to determine how to make life better, not the other way around. Therefore, if you have the means to pay off your mortgage early—or at least by the time you choose to retire—and you’ll sleep better at night for having done so, you absolutely should.
Economically speaking, it should almost always make sense to hold a mortgage if it is at a reasonably low, fixed interest rate and one is dedicating the surplus liquidity to wise, long-term investing. Here’s how I support that claim: Let’s assume you have $300,000 of cash and you’d like to buy a house for $300,000. If you can get a mortgage at 6 percent and you are able to deduct a meaningful amount of that mortgage payment from your taxable income, the effective rate of interest paid is around 4.5 percent. If you are then able to earn 6 percent or 7 percent investing your cash, you can see how you’re able to act as a bank would, and make money on the spread between the amount you are paying and the amount you are earning (although you need to be careful, because you may also have tax to pay on interest income, dividends, or capital gains). If you are young or behind on your retirement savings, consider following this path to help grow your asset base.
But, let’s assume in the above scenario that in addition to the $300,000 you had in cash, you had another $1 million, an amount you had determined would supplement your Social Security and pension income to maintain your desired lifestyle. Additionally, having a $300,000 mortgage—or any amount of debt for that matter—would cause you a material amount of stress. That’s when I would suggest sacrificing the spread, which is not guaranteed, for the peace of mind that is.
From whom did we learn to develop poor financial habits? For starters, Uncle Sam. Because this book is geared primarily toward personal finance, I don’t want to divert too far into the financial woes of our government, but be assured that although government finance seems far removed from our personal lives, it has, does, and especially will be having a very significant impact on our personal finances. If you’re interested in learning more on this topic, check out the movie, I.O.U.S.A. You can find a link to its web site on www.ultimatefinancialplan.com.
Once your cash flow is guided by the healthy discipline of a reasonable budget and you have established sufficient emergency reserves, bad debt should be a thing of the past. Your finances will be running like a business, and you’ll have the opportunity to use credit cards to your advantage. I put virtually everything on a credit card that is paid off every month, accruing points with each purchase. I pay no annual fee, no interest, and each year, I get enough points to add a meaningful chunk to my Christmas present budget category!
Timely Application
Personal Debt Audit and Debt Elimination Plan
If you refer back to the Personal Balance Sheet you created, you will have already compiled your debt information in the liabilities section. Next to each liability, put an “X” next to bad debt and a check mark next to better debt. Then, transfer the bad debt to the Debt Elimination Form available on our web site and customize your Debt Elimination Plan. List the debts in the order in which you will pay them off. If you want to get that ball rolling faster emotionally, take Dave Ramsey’s advice and pay your cards off in order of smallest to largest balances. If you want to save the most in interest payments, list the debts from the largest interest rate to the smallest.
When you make that last payment, celebrate! Take your next month’s payment—a significant chunk of cash flow that you’ll now be able to plough into more generous budget categories and investment for the future—and throw yourself a party. Invite family and close friends who’ve supported you throughout, and enjoy the peace of mind that comes with being debt free.
If you don’t have any Xs on your Debt Audit because you only have better debt, you need not put yourself through a financial boot camp, but deliberate over the debt you do have and consider whether or not a debt repayment acceleration plan may be right for you. If so, use the Debt Elimination Form to plan your course of action.
Visit www.ultimatefinancialplan.com to find a template to use for your Personal Debt Audit and Debt Elimination Plan.
Tim Maurer
I have a good friend who started investing some of his spare time and cash in a residential real estate business several years ago. He made good money on a couple of transactions, and then came 2008. In no time, he was upside down on more than one property with no additional lines of credit on which to draw. Initially, he was very distraught. How could he have gone so fast from having more materially than the average person to a negative net worth? Did this mean he was a bad husband? Father? Steward? After struggling with this reality for months, he sent me an e-mail with some God-given wisdom—in this case, it was in the form of two symbols. The two symbols on which he focuses when he starts to ruminate on his worsening financial situation are the dollar sign and the number zero. $0, because that is precisely how much you will take with you when you leave this earth.
Do you see the irony? He brought himself to financial ruin because he was too focused on rapid material accumulation—more. My friend got all the way to bankruptcy before realizing that Affluenza is a lifeless pursuit. He’s been cured of Affluenza and is enjoying rebuilding with enough, but he still has a black mark on his and his wife’s credit that may make it difficult to get a car, job, or house for the next seven years. Don’t wait until you’re faced with $0 to address your debt demons.
Unfortunately, being on a firm financial footing in your household is not a cure-all for Affluenza and the undying quest for more, but I do have a cure to offer—giving. Here are the three reasons why:
1. Personally, you’ll feel good. Apparently we are wired to receive a physiological benefit from giving. That same sense of satisfaction that you get from a compliment from your friend or a raise from your boss comes from an endorphin rush sent through your body when you give. In addition to these individual senses of satisfaction, you will gradually feel a greater sense of control over your own financial situation when you give to others. This positive response is especially heightened when you are able to connect yourself physically—not just fiscally—in this act of giving.
2. Mysteriously, you’ll actually have more money. Once in a pattern of giving, you have a heightened sense of the needs of others, and the excess in your own budget. The net effect is that you may find yourself choosing to purchase one or two fewer five-dollar lattes per week, staying in occasionally instead of going out, and finding more money in your bank account.
3. Practically, you’ll save money on your taxes. When you give to a qualified charitable organization, you will generally receive an income tax deduction. Talk to your CPA to see how this will affect you personally.
Ultimate Advice
Conventional wisdom would say that the less you give, the more you have. The converse is true. The more you give, the more you have. Abundance creates the ability to give; giving creates more abundance. I don’t mean this simply in financial terms. This principle is true in every area of your life.
The Ultimate Gift
As the ancient saying goes, “If I give water to others, I will never be thirsty.” The benefits of charitable giving—for everyone, not just the wealthy—may be just as meaningful to the giver as the recipient.
1. Dave Ramsey, The Total Money Makeover (Nashville: Thomas Nelson, 2009).
2. Carmen Wong Ulrich, The Real Cost of Living (New York: Perigree Trade, 2010).
3. Carmen Wong Ulrich, Generation Debt (New York: Time Warner Book Group, 2006).