Moneywise24 Personal Finance

When I read through many personal finance and money management blogs, I feel that a great importance is being put on reducing debt and leading a debt free life. I do agree with many standpoints about leading a debt free life. But still, I also believe debt can provide a true benefit, depending on the kind of debt, its use, how it is being paid back, and what it is used for. I call it flirting with debt, because debt can contribute to a particular life quality, but it can just as easily ruin families.

Remaining liquid

In the world of accounting and finance, there are this magical word liquidity. Liquidity simply refers to one’s ability to pay debt when required, and in terms of accounting this is usually measured by using the quick ratio. The quick ratio expresses the amount of units available in relation to one unit of debt. The formula is the following:

Quick Ratio = Total Assets / Total Liabilities

I tend to see liquidity as a form of insurance: I have the ability to repay my debt instantly whenever required. How one calculates his total assets might be different for each person. Myself, for example, I include cash, cash equivalents, stocks, and stock options. However, I do not include my mutual funds, which are meant for retirement purposes, as part of calculating the quick ratio.

Also, I tend not to put too much value on my current salary, simply because I know that salaries can change, or in bad economies companies might cut back on jobs. If I can pay for my debt now, there is no guarantee that I will be able to do so in one year from now.

The intention to grow

I intend to grow, and to further develop, at a financial level, but also regarding my health, or at a spiritual level. For this reason, I closely watch what the debt is intended for.

If a loan is simply used for an expense, which is likely to decrease in value over time, or of which the costs will be greater than the increase in value over time, it is quite destructive. I feel buying such items with a loan is merely an expression of my impatience of not being willing to wait to buy the item when the funds are available. Even worse, I would be willing to pay an extra fee, in order to pay the loan amount of a greater period of time, leaving me with a lesser amount from my income each month, and thus decelerating my growth and financial development.

What I would be really looking for is acceleration of my financial development. This means, that if I take a loan, it should provide a real financial benefit. Not only should there be a benefit over the long run (e.g. increase in real estate price, or the increase of value of a rare wine), but it should also cover for my monthly expenses, leaving a little bit extra.

Payments due vs. return

So, when thinking about taking a loan, I ask myself one important question:

Is the monthly return I get from the item going to fully cover my monthly payments?

The item I buy using the loan needs to have a true benefit, that can cover for my payments. For example, I have quite a huge loan which I took in order to study for my Bachelor’s degree. Had I not taken the loan, I would not have studied, and I would have earned at least 30% less with a job I probably would not like. Therefore, the loan has paid out, and it is directly visible on my monthly paycheck.

Alternatively, this question could be asked for virtually each and every item. And even if there is no return at first sight, could there be a possibility to create a return from it? Take real estate for example: I could buy a home in order to live in it, and it would provide me with no income; or I could find someone to rent it, and have an income from that.

The use of credit cards

Generally, I consider credit cards also as being a loan. Why? Because I can buy an item now, and pay for it next month. I do track all my finances, and I know exactly how much I spent using my credit card, so I always know that I can pay for my bills at the beginning of next month. However, many people don’t. In fact, many people need to pay for their outstanding credit card payments in installments, which can be extremely expensive.

I use my credit card as a sort of an emergency account. If I quickly need something, urgently, and I don’t have the money for it now, then I’ll buy it (for example I need a white shirt for tomorrow’s job interview). But as soon as I can postpone the purchase for a month or two, I will postpone it.

I find debt a useful instrument in order to grow financially, and I tend to look at it as another tool for accelerating growth. Still, debt is to be handled very carefully. If it is constructive, and it can contribute to my income, I would consider taking it. Still I would carefully consider my liquidity as well as some worst-case scenarios. What would happen if I’d lose my job? What happens if I get sick and I can’t work for 2 months. What happens if my stocks drop by 50% in value during another recession? Similarly, I tend to stay away from destructive debt, unless it cannot be avoided.

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Without doubt, since the world’s first credit card, issued by Diners Club, credit cards have become an integral part of our lives. Some people swear to have only one credit card, whereas others are committed to having different credit cards for different purposes and needs. Nevertheless, using credit cards unwisely can potentially lead to great money losses, increasing debt, reduced credit rating, up to complete insolvency.

Credit cards exist with many different features and terms and conditions, but they have one thing in common: they will usually cost money in one way or the other. Either credit cards come at an annual fee, or you will pay charges or interest on monthly installments, ATM withdrawal fees, or foreign exchange fees when abroad. For this reason, credit cards should be handled with great care, always aiming at holding a grip on one’s own personal finance.

The best way to manage credit cards is to simply have only one credit card. Credit cards are a necessary feature in many situations, such as when renting a car or conducting online purchases. However, when you have only one credit card at your disposal, it is much easier to overlook the associated expenses. Firstly, many banking institutions issue credit cards free of charge, usually provided specific conditions are met. You will need to do some research, but on the long run this might save you some cash annually; why pay for an annual fee for a credit card if you might not even use it during a given year? Additionally, the terms and conditions may vary greatly for each issuer. This includes ATM withdrawal fees, foreign exchange fees, or fees when you lost your credit card or when it becomes stolen.

One of the biggest dangers of credit cards is the temptation to spend more on items, and to pay back the money using installments. Banks will usually always ask some form of late payment fees, for which yearly interest rates are far from moderate. On average, people will spend 25% more money on items bought with a credit card than they would have otherwise when using regular cash. Additionally, since the money is not immediately debited from the bank account, individuals tend to lose their reality for the spent money. At the latest next month, when the bill arrives, people see the real consequence of their spending. This causes a new problem: due to the mindless spending, people may need to pay items with a credit card again, since otherwise they would not have the required money on their bank accounts.

This spending pattern may result in a mean and vicious circle, causing people to slide into debt even deeper. In such an event, it is not uncommon, that people start applying for additional credit cards in order to create an imaginary spending freedom; the realization that unpaid debt is accumulated is suppressed, and people start living off debt in stead of equity.

Credit cards can offer some necessary freedom, but they can also be quite dangerous for those with poor personal finance capabilities. Therefore:

• Commit yourself to owning only one personal credit card, and stick to it. Do you research as to the pricing and terms and conditions, in order to pay the least possible fees.
• Track all your credit card expenses. Credit cards tempt to mindless spending, but the money will be debited in one way or the other.
• Always pay your bills online. Paying late or using installments creates additional, unnecessary interest, making it harder to pay off debt. In the end, you purchased an item or service, so you will need to pay for it.
• When you are about to purchase an item with a credit card, think about your motivations. If using the credit card is the only possible way to pay for the service (think about car rental services or online shopping), then go ahead. But if your sole motivation is because you do not have the necessary cash to purchase the item otherwise, what makes you think that you will have the financial means next month? Or the month after that?
• Think about your motivation about shopping general. Do you shop because you truly need specific items, or do you shop because it makes you happy and feel good? In the latter, it may be well possible that you are simply burning your cash on items you do not really need. In this case, you may think about thinking over your motivations to go shopping, or in extreme cases think about counseling.

This article is also available on The Man Experience.

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Being in debt has become quite normal in today’s world: people buy real estate and take a mortgage, a loan is taken in order to buy a car, a television or the newest Playstation is quickly bought with the credit card, and this month’s phone bill seemed to bit slightly higher than usual. Actually, debt does not have to be all that bad… if it planned and under control.

And this is where problems arise. Often, debt is not under control. It seems to increase, a second credit card is being applied for, and it seems like a never ending story, until at a certain point the debtors want their money back, and then…

uh-oh.

The worst that can happen is when the complete existence of a person is about to collapse completely; real estate is confiscated by the bank, credit cards are being blocked, in many countries debtors have a certain right to claim a part of the net salary of the individual directly from the employer, and the story goes on. The worst that can happen is to file for a personal bankruptcy. However, if you have not yet reached that stage, perhaps there is still something that can be done.

A few simple things might help to reduce debt. Reducing debt is never fun, but it is the price to pay.

Track your income and expenses

The very first thing you need to do is to track your income and expenses by the cent; it will make your cash-flow visible, and it will allow you to plan and make a budget. Assuming that you have money to spend, the easiest way to keep book is by using Excel, or another spreadsheet program. For each transaction, you will need to need to make an entry in your ledger, so that by the end of the week or month you can it all up. You can then compare the totals of your expenses with your income, and also with the budget you created.

Save where ever you can

Rigorous expense reduction is the next step. Here, you need to know the exact difference between needs and wants, and it is absolutely essential that you concentrate on what you really need for a living, and how you can make substituations in order to live more cheaply. For example, you may want to investigate how Skype could help you as an alternative to stay in touch with friends, you may want to use public transportation more often, or you may need to give up your daily visit to Starbucks.

Hire a debt consultant

In many countries, there are debt consultant who are either subsidized or fully paid by the government. Find out if this is the case, and hire someone who can help to get you out of debt. Firstly, this person will give you a very precise picture of your current situation. But more importantly, he is also an independent consultant, who is able to engage in negotiations with debtors if applicable. By hiring a debt consultant, debtors will see that you are willing to do everything to reduce and pay off your debt, and thus they are more likely to engage into an agreement.

Do not create new debt

Don’t overdraw your bank account, don’t take any new loans, and destroy your credit cards. The last thing you need is a new loan of any kind.

Assess your income

If being unemployed or having a very low income is one of the reasons for being in debt, you may want to assess your current position; what do you have to do in order to get a job, or a better paid job? Do you need education? More experience? Or perhaps there are already some opportunities for the taking. Pursue your career if you can. Browste the job postings, and build on your network.

Reducing debt is not an easy task, especially in a world where money seems to play such an important role, and where companies want to motivate us to spend more of it via sophisticated marketing strategies. However, being debt free is something to look forward to, and in the end: there are any more important things than money alone.

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