Good Debt, Bad Debt; Knowing the Difference Can Save Your Financial Life

Excerpted from
Good Debt, Bad Debt; Knowing the Difference Can Save Your Financial Life
By Jon Hanson

If we could build our lives around bumper sticker truisms, the two above would be a good start financially. We spend much of our time, effort, and passion on trifles. We half apply proven methods and then stubbornly decide that they won't work. Some of us throw out the old bucket before seeing if the new bucket will hold water. Each New Year's Day, millions of Americans seek a new bucket and resolve to change their ways, get out of debt, lose weight, or spend more time with friends.

At their core, the concepts of Good Debt, Bad Debt are easy to understand but hard to apply. What I have been taking pains to show is that financial success is rather simple, and that daily actions decide the realities of tomorrow. There are few things, aside from health, that affect as many areas of your life as do your finances. Who you are financially determines not only where you live, and maybe even how long you live, but also how many other people you can help in life. Understanding the concepts of the debt effects, emotional management, burn rate, and delayed gratification can change your life. If you understand and apply these principles in your life, you will finish far ahead of the majority of people in this consumption-driven society.

I began in the Preface by telling you that the idea for Good Debt, Bad Debt came from wanting to leave a written record for my children. We will all leave a legacy, good or bad, or, as I quipped a few days ago, "He left not so much a legacy as a stain."

It would be hard to believe that we've been put on this earth to live lives of debt, regret, and broken dreams. Yet it is not hard to believe that others would wish us to live in slavery to debt, especially if it gives them power over our lives or enriches them personally. Here is the rub. To whom do we listen? Our consumption-driven culture says, "Shop until you drop. You deserve the best!"

Many seem to follow the consumption-driven plan, leaving this earth with little or nothing as a legacy to either family or charity. Some leave a legacy of debt. That's worse than the father in the Temptations' song: "Papa was a rollin' stone, and when he died, all he left us was alone." I suppose that you could change it to "and when he died all he left us was a loan."

Once we begin to see that we are falling behind and retirement doesn't look as we thought it would, many fall prey to get-rich-quick schemes. Certainly some people do get rich "quick" but generally it's after a long period of study and effort. It is disingenuous to imagine ourselves millionaires while not even taking steps to first be thousandaires. Remember Longfellow's words, "Most people would succeed in small things if they were not troubled with great ambitions." This is how most of us fail, by ignoring the small things, the simple daily duties of life that are really the building blocks of our greater ambitions.

So, how then shall we proceed? If you are blaming circumstance, government, or other people for your financial status, you need to stop. This robs you of your passion-I know! A few years ago I could have written an entire book on blaming others. It is easy to think, If I made more money, I would have better spending habits. Blaming lack of savings on income is like blaming adultery on marriage.

I have tried to impart one simple message: think! Think about how today's actions will affect what you can do in the future. Your financial future needn't be a vague destination when you do what you know is right. What is right? I'd say it is a plan based on sound financial principles. It's a plan you can mathematically verify. If your plan is given time to work, together with even relatively small contributions, it can grow to a large enterprise. Be an optimist by inclination and a skeptic by training. What to do is simple; carrying it out over twenty years or more is where it becomes difficult. Maybe you just thought to yourself, Twenty years? Is he nuts? I don't have twenty years to work, plan, save, and invest. I might well ask, "Then, what will you be doing? If by process of elimination you aren't doing what is right, aren't you doing what is wrong?"

We, the Jury ...

The story of Good Debt, Bad Debt is really one of stewardship and temperance. The best thing we can pass on to our children is a habit of prudent stewardship and financial temperance. By stewardship, I mean careful forethought and planning. By temperance I mean the right use of the right things at the right times. In the preceding I have presented a case for the importance of understanding the debt effects, control of emotions, burn rate, and delayed gratification. You now are the jury foreperson; convene a jury of your friends, especially your financially fit friends, to discuss them. You then render the verdict.

The concept of Good Debt, Bad Debt is that not all debt is necessarily bad, any more than all carbohydrates are bad. I have read a few of the books that preach total abstinence from debt. And that is probably not a bad program for many people. It's certainly better than being besotted with consumer debt. Since we are not talking about teenage sex, I favor a program a bit more liberal than total abstinence!

The idea of taking something historically thought of as bad and calling it good is more than a marketing angle or hook. The proper use of debt can be good. It can be a tool, although no less dangerous than a powerful handgun, and judicious use of debt can build wealth. You would only have to read a few biographies of great men, or consider for a moment the purpose of the stock market, to see the effects of good debt (and, sadly, bad debt). Sure, invest in the stock market if you are educated about it. But if you do invest in the stock market, do so after purging yourself of bad debt or any debt that does not support itself. Looking in The Wall Street Journal every day for a good investment while loaded with bad debt is like lusting for salt while dying of thirst. The good investment is getting rid of bad debt.

People are always asking me, "Is there really such a thing as good debt?" A good logician will tell you that the existence of a thing is indisputable proof of its possibility. The key to good or bad debt really is a matter of collateral or security. Warren Buffett has used the "good debt" philosophy for years. He buys below market or does not buy-it is all about value investing, nothing more, nothing less. If what you owe for can easily pay its way by being sold, or hopefully from cash flow it produces, then it is good debt. Whenever debt is used for greed, impatience, or an appearance of wealth, it rarely becomes a blessing. While greed and impatience may get a pass once in a while, debt employed to make us appear to be something we are not is always bad debt, and generally has consequences far above the interest paid.

Success is not fully represented by land, stocks and bonds, or cash. In addition to financial capital, we need to add to our store of intellectual capital and spiritual capital. A great number of books have been and will continue to be written on wealth and success. These are perennial topics, and even though comparatively few people will become rich, there is little secret about how to do it. William Matthews in Getting On in the World wrote, "The pith of all the world's wisdom on it [getting money] is condensed into a few proverbs. To work hard, to improve small opportunities, to economize, to avoid debt, are the general rules in which is summed up the hoarded experience of centuries, and the most sagacious writers have added little to them."