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Personal
Financial Basics: On Debt
Is debt a good
thing or is it just bad, no matter how you slice it? Usually,
if you
are the one in debt, it doesn’t feel very
good. Can we then lump it all together into one neat package labeled “Nasty”? Firstly,
we should understand that, like money, debt is not inherently good
or bad. Rather, the virtue or vice of debt is illuminated by how
we use it. In a moment, I’ll give you an easy exercise to
help better understand debt.
Three Kinds of Debt
Because
debt is not all the same, let’s divide it into three
categories in order to better understand more of how you are using
credit.
- Consumption
- Wasting
Assets
- Education/Investment
Consumption
In
this first category are the following: food, gas, utilities,
telephone charges,
cable
TV, entertainment, and vacations. In other
words, anything that is “used up”, and must be replaced
or replenished, falls into this category. Anytime credit is used
to buy an item or service or experience in the consumption category,
a big red flag goes up.
Wasting Assets
Wasting
assets include clothing, toys, furniture, carpet, decorating, and
automobiles. These are items that, once purchased, decline in
value over time.
Education/Investment
In
this third group we find such things as tuition and books or
business startup costs.
The Challenge
Whenever short-term
items or situations are financed with long-term dollars, you
run into trouble. Consider this; if you go out to dinner tonight,
and put the bill on your credit card, you run
the risk of placing that meal into long-term financing. If you
pay off the card at the end of the month, then there is no problem.
But for every month that you carry a balance on that card, you
are–in part–financing that meal. Even with the current low
overall rates, many credit cards continue to run interest rates
of up
to
18%. If you chronically carry a balance on your card(s), you
could wind up paying for that meal twice, or more. The same can
be
said regarding groceries, gas for the car, light bills, clothes,
or decorating
items.
The Exercise
Gather your credit card statements for the past three months.
Go through each purchase and decide which of the three categories;
consumption, wasting asset, or education/investment best describes
that purchase. Write a 1, 2 or 3 to the left of each purchase.
Now, add
up the ones, twos and threes to see where the greatest percentages
of your purchases are. If you find that the highest
percentage of purchases is in the consumption category, and you
carry a balance on your card(s), then you are likely abusing your
credit.
The Principle
Though credit used for consumption can provide great convenience,
if abused, the downside far outweighs any benefit of such convenience.
So, avoid using credit for consumption or wasting assets. |
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