From Success to Significance

Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life
by Jon Hanson

(Page 5 of 7)

Suppose you wish to change careers? If you have a high debt-to-income ratio, debt will certainly be a deciding factor. Following your passion and moving from success to significance careerwise may depend on whether you can downshift from corporate executive at $120,000 a year to teaching children to read at $0 to $30,000 a year. Or perhaps you simply want to take a few years off and write a book. That's what I did, though I had a lot going my way - while my income dropped by over 80 percent, my wife's income increased by over 25 percent. The math does not sound favorable, but our expenses are so low that we have been fine. The interesting thing is that if I had consumer debt, car payments, and high housing expenses, you would never be reading this book. I simply would not have been able to quit my real estate business and take two years to write this book if my expenses or burn rate was large.

Most of us unknowingly choose servitude when we buy into the popular culture of "you can have it all." You can - when you have earned it. Spend the first ten to twenty years of your working career saving and investing 15 to 20 percent of your income rather than choosing to spend 15 to 20 percent of your income to service bad (consumer) debt. If you begin now, you will earn and deserve your freedom.

Freedom, as a concept, is like a hill: often it looks better at a distance. Close up, you begin to see that it can be a lot of work to climb to the top. Freedom means something different to almost everyone. Someone might think that freedom is just having the bills paid. Another person might think that freedom is all the bills paid and $3,000 a month retirement income. And yet another person might think that he or she needs $10,000 a month or more in order to retire. For our purposes, let's just say that financial freedom is a lack of necessary worry or concern about money.

Many people have created fortunes from far less income than you are currently earning, even when adjusted for inflation. When financial difficulties begin, many people believe that they are worse off than anyone who went before them. When you are debt-free, the real freedom is not just what you can do, but what you don't have to do. You are free from the invisible hand of debt.

Loss of Cash Flow. Surely this is the most obvious debt effect. This effect is first noticed when you begin to run out of "walking-around money," a few dollars for incidentals. While most of your disposable income covers the basic necessities, a portion that could be used to eventually replace your job is busy repaying bad debt. While you may not be able to eliminate every bit of consumer debt, it's a pretty safe bet that you can pare it down and begin to invest for your future. If you are spending 15 percent of income on bad debt, the first goal is to get that down to 10 percent, then 5 percent, and eventually nearly zero. Do this while redirecting the cash flow to savings and investments, and eventually this fund alone can replace your job. This won't happen in a short time, but with diligence over ten to twenty years, the results can be amazing. How different would your life be if all the money you spend on consumer debt payments went into savings or an investment? Now consider what that would have meant over the past twenty years or what it will mean over the next twenty years. If you are age forty-something, you may project both ways: to the past and the future.

While you may lament how low the return on savings rates are now (there are other things to invest in), over the years you will realize that returns are not fixed. In 1981 some savings banks were paying 15 percent per annum. The return is not the lesson here, though - the savings habit is the lesson. In the beginning, don't worry about return. Just make sure that you are stacking up the capital. You must have capital to capitalize!

Many sacrifice their true passions to debt. Soon most of their money is allocated to "reparations" or repaying for past spending. Their passions dull into complacency and are soon forgotten. They lose simply by giving debt too large of a vote in their future. Remember, the past is the past, unless of course you still owe for it. It is hard to move forward while paying backward.

They lose simply by giving debt too large of a vote in their future.

Loss of Time. If you're in debt, you must be somewhere other than where you'd like to be. Arnold Bennett, in his 1910 book How to Live on Twenty-four Hours a Day, wrote, "The beauty of time is that everyone has the same amount and you cannot spend it in advance." Largely, Mr. Bennett is correct. But consider people who are deeply in debt - bad debt. They essentially have spent their time in advance, for they are obligated to be at their jobs to repay their debts. They have spent their time in advance of it arriving. This is what I mean by the term mortgaging your life. Certainly we sell our skills or brawn in the marketplace, but more than that we must realize that what we sell is part of our remaining time. As you grow in wealth and influence, you will value time more than you do today.

The amount of mental energy expended concerning (worrying) ourselves with bad debt vitiates time we could otherwise spend on positive pursuits. Freedom from debt and time with family and friends have begun to edge out weight loss as the number one New Year's resolution in the past few years. Many people desire free time more than additional money. The wise among us deeply value time for family and friends as well as time to write or perchance to think.

Funds already spoken for must remain silent when opportunity knocks.

Loss of Opportunities. When you see a great opportunity for financial gain, it is unlikely that you will be able to take advantage of it, because you will be financially unable to do so. The first rule of all enterprise is to know a solid value when you see it. The second rule is to be able to act on an opportunity when it arises. If your neighbor suddenly decides to sell his extra building lot for 50 percent of its true value but only if he can have cash in twenty-four hours, can you respond? This actually happened to me about a year ago (yes, I bought it). The moral of the story is this: funds already spoken for must remain silent when opportunity knocks. We lose if we have not developed the habit of preparing for opportunity. It is debilitating to sit and recount lost opportunities, but at the same time they should be lessons that we need not miss the next time. We must embrace the lesson, not the loss; embrace the light, not the dark. Truly this debt effect reaches the heart of all the debt effects. It is the silent killer of possibility and promise. I like to refer to lost opportunities as the ultimate invisible depreciation. It's easy to see the effect of depreciation on a new car, an average of $250 or more a month. It's harder to calculate the benefit of having that $250 a month accruing in a liquid investment so you'll be ready to seize a tremendous opportunity.

Copyright © 2004 Jon Hanson. All rights reserved. This excerpt, or any parts thereof, may not be reproduced without permission.

About the Author

Jon Hanson lectures to audiences of all sizes on personal finance topics. A twenty-four-year veteran of the real estate business, he is now a full-time writer and public speaker.