You might think from my last post (see Getting Started - Rule #2) that I believe that all debt is bad. But that's not the case. Sometimes it's OK, and even a good thing to go into debt. How can you tell good debt from bad debt?
The difference between good debt and bad debt lies in what you plan to do with the money. If you are borrowing money to pay for ordinary expenses, like food and clothing, then that is a bad thing. On the other hand, borrowing money to buy a house can be a good thing.
What's the difference between these two cases? For one thing, the house has a long term value that generally goes up over time at about the rate of inflation. The last 10 years have been an exception to this rule, where the prices have shot up and then fallen, but in general this is true. A second difference is that a house provides a service to you over the long term. It gives you shelter and saves you from having to pay rent.
When you put up money today to receive something of value in the future, then this can be an example of good debt. I say "can be" since it all depends on the cost of the loan and the amount of value you expect to receive. You have to do the math to figure out if it is really worth it or not.
Another example of potentially good debt is when you borrow money to go to college (or for any type of education or training). If the training you receive provides you with more income in the future, then you can use that extra income to pay off the debt.
The last example is buying a car. If you can't afford to buy a car, and you need one to get to work, then taking out a loan to buy a car makes sense. The car also provides a service to you, while it lasts, but unlike a house, the value of the car declines over time. In cases like this, you need to make sure that you will have the loan paid off before the car's useful life is over. The other thing about cars is that they will start to cost you money for maintenance as they get older. So it's best to pay off a car loan over a 3-5 year period (for a new car), so that when the big ticket maintenance items start to happen, you will already be paid off.
So, to sum it up, debt isn't good and it isn't bad. It's what you do with the money that counts.
Friday, December 17, 2010
Sunday, August 29, 2010
Getting Started (rule #2)
The first rule was aimed at getting you started on the road to having some money to invest. The second rule is aimed at keeping you on track.
(2) You should never carry credit card debt
It's OK to have a credit card, and to use it. Credit cards are very handy things to have, and you should have at least one. But you should always pay the full balance on the card each month. If you do this, then you will never be charged any fees or interest.
If you treat your credit card like this, then you aren't really going into debt, you are just paying your bills on a monthly basis. If your credit card charges an annual or monthly fee anyway, then you should cancel that card and get one with no fees.
Interest and fees seem like little things at first, but they add up over time. Think of them as little vampires sucking away at your money. Just like a little savings can add up to a lot of money over time, these recurring fees add up. And these fees are coming right out of your disposable income.
Disposable income is the money you have left over after you have paid for your necessities, like food and rent. This is the money that is available to you to spend on things that you enjoy, like music and movies. Savings also have to come from your disposable income. So anything else that is coming from your disposable income is an evil that should be eradicated. If it's not fun, and it's not helping you save then why tolerate it?
While we are on the topic of fees and interest, it is also a good idea to get a no fee checking account, for the same reason. Most banks will give you some way to avoid fees, either by maintaining a minimum balance in the account, or by setting up an automatic deposit into a saving account.
One other type of scam to avoid is the so called "free credit report" service. These services may be free to start with, but they all convert to a service that charges a monthly fee. If this happens to you, cancel the service immediately.
(2) You should never carry credit card debt
It's OK to have a credit card, and to use it. Credit cards are very handy things to have, and you should have at least one. But you should always pay the full balance on the card each month. If you do this, then you will never be charged any fees or interest.
If you treat your credit card like this, then you aren't really going into debt, you are just paying your bills on a monthly basis. If your credit card charges an annual or monthly fee anyway, then you should cancel that card and get one with no fees.
Interest and fees seem like little things at first, but they add up over time. Think of them as little vampires sucking away at your money. Just like a little savings can add up to a lot of money over time, these recurring fees add up. And these fees are coming right out of your disposable income.
Disposable income is the money you have left over after you have paid for your necessities, like food and rent. This is the money that is available to you to spend on things that you enjoy, like music and movies. Savings also have to come from your disposable income. So anything else that is coming from your disposable income is an evil that should be eradicated. If it's not fun, and it's not helping you save then why tolerate it?
While we are on the topic of fees and interest, it is also a good idea to get a no fee checking account, for the same reason. Most banks will give you some way to avoid fees, either by maintaining a minimum balance in the account, or by setting up an automatic deposit into a saving account.
One other type of scam to avoid is the so called "free credit report" service. These services may be free to start with, but they all convert to a service that charges a monthly fee. If this happens to you, cancel the service immediately.
Friday, July 16, 2010
Getting Started (rule #1)
This is going to be a column of investment advice. But before you can invest, there are a few things you should take care of first. To start with, you will need to have some money to invest. This means (unless you happen to fall into a pile of money):
(1) You need to make more money than you spend
Another way to put this is that you need to spend less money than you make. It means the same thing, but it can be a more useful way to think about it, since you have more control over what you spend.
Here are two basic strategies for achieving this goal. Which works best for you will depend on your personality, but don't be afraid to try both approaches. First, for the more organized type, you can create a budget. The second approach is to use a set aside. Let's talk about budgets first.
Budgets are really very simple. Just list your expenses by category: food, rent, car and gas (transportation), clothes, utilities, entertainment (movies and eating out), etc. Estimate how much money you spend in each category per month, and compare that to your monthly income. Be sure to include the expenses that only come up occasionally, like insurance and car maintenance.
Then add up the expenses and compare that to your monthly income. If there is no money left for saving, or if your expenses are greater than your income, then you need to look for areas to cut back. Some expenses are pretty fixed, like rent, and others are more flexible. Those are the areas to look for cuts in.
The second approach is to use a set aside. In this system you put a fixed amount of money into a savings account each month (or each paycheck). Then you just have to make sure that the rest of your income will last you for the whole month. This system can work well for people who don't like the budgeting approach. Payroll deductions like 401K's work this way, and are very popular.
The main trick with the set aside is to make sure that it is enough money to cover the occasional expenses. If you spend all your other income each month, then expenses like car insurance will have to come out of savings. The set aside needs to add up to more than these expenses in order to have true savings.
(1) You need to make more money than you spend
Another way to put this is that you need to spend less money than you make. It means the same thing, but it can be a more useful way to think about it, since you have more control over what you spend.
Here are two basic strategies for achieving this goal. Which works best for you will depend on your personality, but don't be afraid to try both approaches. First, for the more organized type, you can create a budget. The second approach is to use a set aside. Let's talk about budgets first.
Budgets are really very simple. Just list your expenses by category: food, rent, car and gas (transportation), clothes, utilities, entertainment (movies and eating out), etc. Estimate how much money you spend in each category per month, and compare that to your monthly income. Be sure to include the expenses that only come up occasionally, like insurance and car maintenance.
Then add up the expenses and compare that to your monthly income. If there is no money left for saving, or if your expenses are greater than your income, then you need to look for areas to cut back. Some expenses are pretty fixed, like rent, and others are more flexible. Those are the areas to look for cuts in.
The second approach is to use a set aside. In this system you put a fixed amount of money into a savings account each month (or each paycheck). Then you just have to make sure that the rest of your income will last you for the whole month. This system can work well for people who don't like the budgeting approach. Payroll deductions like 401K's work this way, and are very popular.
The main trick with the set aside is to make sure that it is enough money to cover the occasional expenses. If you spend all your other income each month, then expenses like car insurance will have to come out of savings. The set aside needs to add up to more than these expenses in order to have true savings.
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