|
Whenever the topic of finance is discussed, it is important
to note that everyone's situation is different and that
financial advice should be tailored to an individual's
particular circumstances with the help of a professional
advisor.
Everyday our mailboxes are flooded with advertisements,
catalogues, and "pre-approved" credit card offers hoping to
deplete our savings and draw us deeper into debt. In the latest
Survey of Consumer Finances conducted by the Federal Reserve,
concern has been expressed that the rising level of debt may
become "excessively burdensome to families." Similarly, the
American Bankruptcy Institute reports personal bankruptcies are
near an all-time high and in 2004, more than 1.5 million were
declared.
Debt is a scary place to be; it is emotionally and financially
threatening. It limits our ability to meet daily expenses,
invest for the future, and creates a long chain of financial
difficulties. The strains put on our relationships due to these
financial pressures make it imperative that we find ways to
effectively deal with debt. Like all problems, it will
dangerously compound if we ignore it, so we must confront it
head on to positively change the condition of our lives.
Permanently resolving our debt situation involves three things:
gaining an awareness of the different types of debt,
understanding the psychology and circumstances that led to the
current situation, and devising an effective debt reduction,
savings, and wealth acquisition plan.
Put simply, debt falls into two categories: investment debt
and consumer debt
Investment debt is an obligation that one takes on in order free
up funds, generate cash flow, and build wealth. It is the
leverage of other people's money (OPM) to purchase assets that
substantially increase in value or produce income. A few
examples of investment debt include mortgages for rental
properties, business loans, and stock margin loans. The best
forms of investment debt produce positive cash flow. When debt
produces positive cash flow, it generates more money to invest
and does not reduce your existing income.
Consumer debt is a financial commitment used to purchase items
that have no substantial resale value or depreciate after they
are bought. Examples of consumer debt include: automobile loans,
personal loans, personal lines of credit, credit card debt, and
more. It can be wise to buy an item using consumer credit, if
the after-tax return on your investments is greater than the
interest rate on your debt. With this approach, you have more
money available to invest at a higher rate of return. This is a
riskier strategy and should only be employed by sophisticated
investors. It is also important to note that one person's
consumer debt is another's investment debt. The money one
expends servicing debt goes to help another build their wealth.
Over time, your goal should be to turn the tables.
The Psychology of Debt
To change your financial condition, you must understand the
factors that have led you into debt and position yourself so
that you will never return to similar circumstances. Common
expenditures leading to excessive debt include automobile
purchases, education expenses, vacations, gambling, medical
expenses, unsuccessful business ventures, and the frequent
purchases of consumer goods and services.
In general, we must become better planners and begin to stop
thinking of debt as the first solution to our problems. If our
debt situation stems from overspending, we must address the
emotional state that drives us to live beyond our means. If it
is due to unsuccessful business ventures, we must learn to move
our enterprise forward through stock offerings, or creative
means like partnerships and the bartering of services. If it is
from necessary expenditures or emergencies then we must develop
the discipline to create special savings accounts and cash
reserves. Once we change the way we think about debt, we are
prepared to implement life-changing solutions.
The most expedient way to deal with debt is through a
two-tier approach of budgeting and investing.
Begin your financial turnaround by writing down the monthly
payment, interest rate, and total amount owed for each of your
debts. Once you know where you stand with each of your
creditors, attempt to lower your interest rates. This involves
calling your creditors and asking for lower rates, transferring
balances to lower interest rate credit cards, or more aggressive
tactics such as home refinancing, to turn liabilities into lower
interest-bearing, tax-deductible debt.
Next, create a realistic budget and eliminate unnecessary
expenses. Take any free cash flow and use it to pay more toward
your highest interest, non-tax deductible debt. On all other
debt, pay only the minimum. Do this every month until that
particular high-rate debt is paid off. Once that account has a
zero balance, use the money you normally would have expended on
your monthly debt payment, plus any free cash flow, to pay
toward your next highest interest rate debt. Continue this
process until all your debt is paid off.
It is important to note that if you have savings, you should use
it to pay down your highest interest rate non-tax deductible
debt. It makes more sense to pay off debt at interest rates of
12-18%, than earn less than 2% interest in a money market or
savings account. Also, remember the interest rate on your debt
is equivalent to the after-tax return on an investment. So, if
you are not outperforming on an after-tax basis the interest
rate being charged on your debt, it is more advantageous to pay
off your debt.
The second aspect of your debt transformation involves
investing. In order to effectively manage and overcome your
debt, make investments that have a return that outweighs the
interest rate on your obligation or that generates cash flow in
excess of your monthly debt payment. Because investing can be
rather complicated and volatile, it is important that you have
as much education as possible in this area. Your first thought
may be, "I don't know much about investing, and I don't have the
time to learn." Well, you must decide if you are willing to make
the time, or choose to work the rest of your life to pay off
your financial commitments. Budgeting alone is a much slower
solution, so you would be wise to develop a mastery of investing
or partner with people who possess such knowledge in order to
expedite the process. Seeking the advice of competent
professionals is a sound way to shorten your learning curve and
prevent costly mistakes. If you encounter an emergency during
this period, you may use your credit accounts as your cash
reserve.
There are many strategies for investing your way out of debt.
Some include starting or investing in businesses and buying
assets that appreciate in value or generate cash flow. The issue
becomes, how do you take advantage of opportunities with little
cash and poor credit? The answer to most questions of lack is
through partnerships. Though we may not view ourselves as
entrepreneurs, we all have viable business ideas inside us. It
is up to us to develop those ideas and approach enough people
until we find partners who believe in us and are willing to
finance or actively participate in our venture. For those who
like the idea of owning their own business, but not the hard
work it takes to develop one from scratch, there are a number of
direct sales organizations that will provide you with business
opportunities for low startup up costs and lots of guidance. All
of these add up to ways of generating excess cash flow to help
pay off your debts and build wealth.
The mentality that created your current financial situation will
not suffice to solve your debt issues. For most, the financial
difficulties we face have taken years to develop, so they will
not be solved overnight. As much as we would like to believe,
there are no incantations or magical formulas for ridding
ourselves of financial obligations, only the disciplined
strategies of sound money management and investing. We must
remember to deal with the issues that drove us into debt before
attempting to implement any strategy. If we do not start with
our own thought process, any plan of action will not be
effective in the long-run and may put us in a worse financial
position. To transform our lives, we must change the way we
think about finance and obligations. On the occasions that we do
use debt, it should be for the purpose of buying assets, not
consumer goods that depreciate or have no value.
About the author:
Vicky Therese Davis, William R. Patterson, and D. Marques Patton
are co-authors of the acclaimed business and personal finance
National Bestseller, THE BARON SON: VADE MECUM 7.
To receive their breakthrough book and over $3,631 in FREE
bonus gifts, visit: http://www.baronseries.com
|
