What Kind of Debt Is Acceptable?

What Kind of Debt Is Acceptable?

Acceptable Forms of Personal Debt Although I have been harsh on debt and believe we should pay cash for as many things as possible, I acknowledge that some forms of debt may be the best way to meet some of our most critical spending needs. When used wisely and sparingly, it can provide tremendous opportunities for economic improvement that may never be available otherwise. In my opinion, the most responsible use of personal debt would be limited to reasonable amounts for education, a modest home, and basic transportation. It may also be prudent for businesses to incur certain forms of debt at sensible levels for expansion that would be impossible otherwise, but we will limit our discussion here to personal debt. Why am I okay with debt for these purposes? Since higher education often dramatically improves potential earning power, and since our ability to earn an income is typically our greatest asset throughout most of our life, student loans may produce a higher long-term return than any other investment we could make. If a student’s parents or grandparents cannot afford to pay higher education costs for her, she may never be able to save up enough money on her own to pay for the schooling required to increase her earning power so substantially. In this case, student loans can be a very valuable tool. Still, we must be careful not to spend more on education than we can reasonably expect to be able to pay back based on the earning potential of employment opportunities related to our field of study. We can minimize the use of student loans by...
Creating a Spending Plan

Creating a Spending Plan

Whether they make a lot of money or squeak by on a meager salary, most people shiver when they hear the word “budget.” Since the “B word” typically evokes such negative emotions, I prefer to call it a Spending Plan. I enjoy thinking about how I am going to spend my money much more than I enjoy contemplating how to restrict myself by living within a budget. After all, money is ultimately meant to be spent, right? Creating a spending plan is a beautiful thing because it is the only way to ensure that our money will go to the things we want most, not just to the things we want now. This is a critical distinction, because the two are often mutually exclusive. We can never have enough money to buy everything we want. Therefore, we should think of our spending plan as a friend who helps us get what we want most, not as an enemy to all happiness. If we have already allocated the proper amounts to taxes, tithing, insurance, and savings, then we are most of the way there. In fact, we do not even have to keep track of where the rest of it goes if we do not want to. The most important thing is to distinguish between fixed, totally necessary expenses (such as mortgage payments and utilities) and discretionary expenses (such as eating out and taking vacations). We must be sure we have enough to cover the fixed expenses first, and then we can spend whatever is left on the extras. In our family, as we have learned to discipline ourselves we...
What Do You Want Most in Life?

What Do You Want Most in Life?

Everyone has a unique perspective on life. When first meeting with a financial advisor, you should share as much as possible about your personal goals and concerns so his or her recommendations will be consistent with your desires. You must clearly articulate what you want most so you can use your priorities as a measuring stick. If you don’t know what you want, how can you effectively decide what to do? Lewis Carroll masterfully captured this concept in Alice’s Adventures in Wonderland, in which Alice asks the Cheshire Cat, “Would you tell me, please, which way I ought to go from here?” “That depends a good deal on where you want to get to,” said the Cat. “I don’t much care where–” said Alice. “Then it doesn’t matter which way you go,” said the Cat. What Are Your Priorities? Here are some examples of what I have articulated as my biggest priorities in life: To be at peace with God, other people, and myself. To have great relationships with my wife, children, extended family and friends (in that order). To help improve the lives of other people as much as possible through my profession and through community and church service. To live a long, healthy, fun life! On the surface, it may appear that these objectives have nothing to do with financial decisions, but they are actually very closely linked. For example, to be at peace with God, other people, and myself, I must be honest in all of my financial dealings. This means that I do not borrow more money than I know I can repay, I pay...
Managing Investment Risk

Managing Investment Risk

How can we successfully manage investment risk? Consider applying the principles of risk management discussed in our article entitled “Four Ways to Manage Risk.” Avoiding Investment Risk We should completely avoid high severity risks that are likely to occur, such as the risk of losing all of our money through gambling or investing in penny stocks. If you feel compelled to gamble for entertainment purposes, just be sure to do so only with however much you would be willing to flush down the toilet. Don’t make it your retirement savings strategy. I am opposed to gambling even for entertainment, though, because it can be very addictive and destructive, and it goes completely against the principles of wise stewardship. Reducing Investment Risk We can reduce investment risk through diversification, which means that we do not put all of our eggs in one basket. Many people who think they are well-diversified really are not. For example, I have met several people who think they are very well-diversified because all of their investments are in U.S. large-cap growth stock mutual funds with a variety of fund families. Typically they are shocked when I point out that most of these funds are actually investing in the same 100 or so stocks, and that many of these stocks are very similar to each other in nature. Sure, they are more diversified than if they were investing all in one stock, but true diversification would include a much larger variety of characteristics, such as geographic areas, sizes of companies, growth stages of companies, types of products or services provided (i.e. financial services, health care, technology, consumer...
Pay Off Debt or Invest For the Future?

Pay Off Debt or Invest For the Future?

Often people ask me whether they should pay off all debts before saving for the future or save first in hopes of earning a higher return on investments than they are paying in interest on debts. This is an age-old debate, and I have heard convincing arguments from Financial Advisors on both sides. The “Pay Off Debt” Argument Some advisors recommend that we liquidate all of our savings and investments except a very small amount, even as low as $1,000, to immediately pay down as much debt as possible. Then they recommend that we use every discretionary penny from each paycheck to eliminate the remaining debts as quickly as possible. After we are completely debt-free, then we can start saving and investing for the future. I admire people who are disciplined enough to follow this extremely aggressive strategy, but it is risky because it does not leave an adequate safety cushion. A $1,000 savings account would not be enough to cover unemployment, major unexpected expenses, or serious extended illness. What would happen to my house if I could not make my mortgage payment for six months due to unemployment? Would the bank cut me any slack because I had been paying them extra for the past year in hopes of paying my mortgage off sooner? Not likely. We should always maintain at least three to six months of living expenses in liquid savings, even if we have debt. The “Invest it All” Argument On the other extreme, some people recommend borrowing as much as the banks will allow and investing it all because they declare we can make more...