How's Being Broke Working for You?

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

(Page 7 of 7)

It's Your Choice, but "They" Want to Help

For merchants who are armed with psychologists, sociologists, surveys, and ad agencies, the typical consumer is no more than a cow being milked by his or her emotions. When you no longer produce the milk - uh, the payments for your excesses - you are shipped off to the bankruptcy slaughterhouse to have your guts ground into sausage and your hide made into leather bags for ad executives. Then, you are returned to the general population as an empty shell, to start the cycle all over again - unless you learned from the lessons of debt.

Have so many of us really degenerated from freedom seekers to mere cows being milked by our emotions? What do you think?

Many foreigners are amazed to learn that we do not teach saving or investing in our public schools. If we do not learn our financial skills from our parents, where do we learn them? Most people, I suspect, are self-taught - usually after realizing that what they have been doing is not working. Others will never learn.

Surveys show that American children are behind those in many developed countries in math, science, and reading but are number one in the belief that they are the best in the world. Unearned self-esteem is much like consumer credit borrowing - one day the bill comes due. Wouldn't it be better if Johnny could actually read and do math rather than just feel that he can? Won't Johnny's self-esteem be better in the long run if he bases his assumptions on hard facts rather than feelings? Won't Johnny's financial future be better if he understands the full effect of his spending? Shouldn't we teach our children to build a solid financial foundation rather than create an illusion of wealth supported by consumer credit?

Can I Fast-Forward?

Søren Kierkegaard wrote, "Life can only be understood backwards; but it must be lived forwards." Ah, I see the problem. Is it worth all the work to develop an Econowise plan? You can answer that question only by projecting forward and looking back.

Suppose you had a videotape of your future and could fast-forward to see if all the work ahead of you would be worthwhile. Can I give you a hint? If you don't change the way you think and act now, your financial future will look pretty much as it does today. But, if you take steps now, you can change the ending. Remember the thumb-worn creed, "He finished on time, because he started on time." Begin now. Only change now can affect the end of your tape.

Your biggest investment should be in your future. Your future is enriched by applied knowledge of your daily burn rate, retirement, education, reading, and study. A definite purpose, a desire, to have a certain future must be at the center of your plan.

We often fear facing the truth about our careers and ambitions because of the effort it will require to override the debt effects. It's easier to maintain the status quo than to strive for your dreams. Are you able to change your career or follow your dreams? Or are you enslaved to bad debt? Debt makes cowards of us all.

Inaction will wear you out!

How's Being Broke Working for You?

Sometimes I hear, "That's too much work! Who wants to spend their time planning and thinking, saving, and learning to invest?" Jim Rohn mocks Joe Six-Pack with this line: "Hey, by the time I get home, have a few beers, watch a little TV, I don't have time to study, to learn - to read!" Mr. Rohn incredulously adds, "And he wonders why he is broke?!"

Let me ask you this: are you getting any rest being broke? For the most part, being poor is more tiring than treading the path to wealth. And the path to wealth is much less depressing. If you have a mind to improve your lot in life, keep in mind that inaction will wear you out!

Good Debt vs. Bad Debt

You can view the differences between good debt and bad debt as much like the differences between good cholesterol and bad cholesterol. Doctors tell us that we need a certain amount of good cholesterol but that too much bad cholesterol will eventually kill us.

We can liken bad cholesterol - LDL (low-density lipoprotein) - to bad debt, which is artery- clogging debt. Good cholesterol - HDL (high-density lipoprotein) - is akin to good debt that clears arteries and keeps you financially healthy. Part of this financial artery-clearing effect is an increase in cash (blood) flow.

I always thought that zero cholesterol was supposed to be my goal. Not so. Apparently if your HDL measurement is under 35, it's a health risk. Your total HDL rating should be 40 or 50, and up to 70 or 80 of HDL can actually protect you against various diseases.

Likewise, some people think that zero debt is best. It sounds good, doesn't it? But zero debt also means zero growth or at the most a low growth rate. Perhaps we can learn from the HDL example. If it takes some HDL to be in good physical health, let's take the mental leap that it takes some good debt to be financially healthy.

The definition of good debt is similar to that of good cholesterol. It keeps the arteries clear. Good debt keeps the cash flow running smoothly and the funds pumping. When you read the definitions below, notice that good debt is a debt on assets that produce a return above their cost. It is debt on assets that create cash flow in excess of the cost of the debt. It is not debt that kills. Remember this: when you use debt to pay for something, it is not a payment in full, but merely a claim on your future time and earnings.

Good Debt

• Earns its keep
• Increases your net worth or cash flow
• Secures a discount that can be converted to cash or net worth
• Creates leveraged position ($300 out, $400 in monthly)
• Examples: debt for real estate at a safely leveraged level, debt for education that can be applied for a return of capital, debt for a business you are competent to operate

Bad Debt

• Is typically for consumption
• Decreases your net worth or cash flow
• Examples: Car loans that rob your retirement fund, continuing credit card debt, living on student loans, furniture loans, loans for rapidly depreciating items, loans for parties, weddings, or vacations be applied for a return of capital, debt for a business you are competent to operate Bad Debt. Bad debt is money owed for trinkets, nonessential essentials, an excess of items, and other consumer junk.

For example, a nonessential essential could involve paying $599 a month for a Lexus, without the commensurate cash flow. It is true that you need a car, an essential, but you don't need a car that costs $599 per month. See Chapter 8 ("Driving Your Life Away").

Generally, credit cards, unless paid in full monthly, involve bad debt. Approximately 50 percent of Americans make the minimum payment or don't pay their balances in full each month. Certainly we need clothes, cars, washers, dryers and many other consumer items we sometimes charge. Bad debt usually begins to pile up when we allow emotional spending or spending without regard to consequences. Without a spending plan in place and clear guidelines, we accumulate bad debt quickly.

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.