The 4 Horsemen of Personal Finance: Number 2

Welcome back the second pillar of my “4 Horsemen of Personal Finance.”

Since last night’s post may have been a little wordy… easy to talk about at length since attitude really IS everything… I will try to keep this one short(er).

drowning-in-debt

2. Debt will drown you

Debt is not your friend.  Debt is like that buddy that asks if he can sleep on your couch for a couple nights while he gets his act together, but 2 months later he is still there, your favorite tshirt is missing, and all the frozen pizzas you had stockpiled in your freezer are gone.

Unfortunately, debt for most people is completely commonplace – an acceptable, everyday part of life.  Like countless others, I received my first credit card in the mail my sophomore year in college despite the fact I had never signed up for one.  My first thought when I opened that thing…”Ooh… free money!”  Touche Bank of America, touche.

As are most banks and credit card companies these days, the people that issue cards this way are smart.  In the most basic sense, they are modern-day, white-collar drug dealers.  They offer credit instead of crack, and as the consumer, you use plastic instead of a pipe.  They know that the sooner that get you hooked, the sooner you will become loyal to their brand and become a consistent, long-term revenue generator through transaction fees and finance charges.

It is very easy to fall in this trap.  When you approach a limit on one card (and assuming you are making your minimum monthly payments), you simply pick a winner out from the pile of credit offers you get in the mail every week and complete a 0% interest for 12 months balance transfer and continue your spending.  Do  I speak from experience on this subject?  You bet.

What I didn’t understand then is that credit, in its most basic form, is a tool for people who are lazy, in denial, or both.  We live in an age of instant gratification.  People no longer want to wait to purchase the things they want, nor are they willing to put in the time and effort to plan their purchases properly.  They convince themselves again and again that using their credit card is ok because that is what they are used to.  To make matters worse, when we use credit cards, we actually spend more money than we would if we were paying in cash.  Studies have shown that in some cases people are willing to spend more than twice as much on a purchase when they pay with credit.  So not only are we spending money we don’t have, we are spending more on average for our purchases.  Bad (and expensive) combination!

The title of this pillar is “Debt will drown you.”  What I’m stressing here is that if you are currently buried in credit card debt, car loans, financed furniture, student loans, etc., you really need to do some soul searching and ask yourself if you are happy going through life knowing that you will always be paying everyone else before you can pay yourself.  If you can never pay yourself, you can never build wealth.  If you can never build wealth, you will be living yourself on someone else’s terms indefinitely.  In short: you need to focus on getting out of debt.  It is still possible to still get the things you want and need without borrowing, it just takes the right attitude (and as we already know… attitude is everything!).

If that isn’t enough, here is some additional motivation for you.  Let’s assume that you have always driven new cars that you trade out of every 3-4 years with a payment of $400/ month.  Using my favorite compound interest calculator, we know that due to the power of compound interest, if you took that same $400 and invested it earning an average rate of return of 10% (which equals the average rate of return of the S&P 500 since its inception), after 30 years you would have almost $790,000!!!  Not sure about you, but to me that is ALOT more appealing than the small amount of satisfaction I would receive by always driving a newer model vehicle.

If you need a gameplan to get out of debt, there is none better than Dave Ramsey’s “Debt Snowball” method.  This method basically requires that you arrange your debts smallest to largest, and after paying your basic bills (food, shelter, electricity, etc.) and making your minimum payments on your other debts, you throw whatever is left over towards the smallest debt.  When the smallest debt is paid, you move on to the next one which, due to the extra money left over from paying off the first debt, you can now attack with greater effectiveness.  In my opinion, this method is by far and away the most effective way to rid debt from your life.

Pillar 3 coming tomorrow!