Personal Finance (Sec. 3)

FUNDAMENTALS OF FINANCE

A Guide for Helping Professionals

Adam J. McKee


SECTION 3: Debt


This work is licensed under an Open Educational Resource-Quality Master Source (OER-QMS) License.

Open Education Resource--Quality Master Source License


Debt is bad.  Some kinds of debt are worse than others.  Always avoid debt, and when debt is unavoidable, get out of it as soon as possible.  Most people understand that debt is bad because it negatively impacts your monthly cash flow.  We’d all be living large if we didn’t have bills!  But debt is bad in other, less obvious ways.  If you aren’t related to the lender, then debt costs you money in the form of interest, and often in the form of fees that you didn’t expect (learn to read the fine print!).  Most people get that idea, but they seriously underestimate how much it is really costing them.  People also fall into the trap of being optimistic about the future; we assume that things will be better in the future and the debt will be easy to pay off given our new, better circumstances.  Life doesn’t often work that way.  When you get a raise at work, it probably will just catch you up with inflation for the year. If you don’t get a raise, then you are even further behind.

Probably the most common debt producing scenario is simply acting on impulse.  Dinner and drinks after a long week sound nice; put it on the card.  Credit card debt can creep up on you in an alarming way, and do it faster than you ever thought possible.  From the perspective of a stockholder, Amazon is one of the most amazing companies of all time.  I am convinced that the biggest money making innovation that Amazon has is its “one-click ordering.”  “That’s really cool!” you say as you browse through items selected especially for you by a scarily accurate computer algorithm.  It only costs $19.95–what a deal!  Click.  Your credit card balance just went up $19.95.  Repeat that scenario a few dozen times a year, add in an astronomical APR, and you have a card you can’t pay off this decade.  You must develop the discipline to not use credit unless it is absolutely necessary.

References and Further Reading

I am hard on debt, and I think I am correct in giving that advice to the average person.  For the business minded person who can turn debt into cash flow, debt is another matter.  To understand the difference between the bad debt I preach against and “good debt” that builds cash flows, read the following book:

 


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