The secret to wealth is spending much less than you make.
In “The Millionaire Next Door”, Thomas Stanley and William Danko describe many of the unexpected characteristics of people with a high net worth. The starting point for a financially successful life is first learning to live within your means; spending no more than you earn. After you have mastered living within your means then you need to learn to live on much less than you earn.
We often get caught up in the trappings of conspicuous consumption, we admire the brand new $60,000 car, we are jealous of the vacations to Hawaii our friends take, and we wish we lived in a bigger, newer house. However, that new car probably represents a big hit to someone’s savings or worse, they charged the down payment on a high interest credit card and they have a $600 monthly payment for years before they fully own this depreciating asset. After 5 years their $60,000 expense and $10,000+ of interest payments is worth less than half that amount. They have lost $40,000 in a few short years. Not a very effective way to build net worth.
In today’s world it is very easy to spend tomorrow’s income on today’s life style; just put it on the plastic. Hopefully, you have paid it off by the time you throw it away. The costs of the debt can very easily double the price you pay for an item.
There are two kinds of debt. The worst kind is life style debt. Borrowing to pay for a new television or new furniture, in other words items which rapidly depreciate, will leave you forever broke. If you need a new television, first be sure this is a need and not a want. Getting a bigger set just because it is so much better than what you have, and it is so embarrassing to have anything but the latest model is not a reason to go into debt. If your television has broken and you don’t have the cash for a new one, cancel the cable, and start saving. The same could be said about cars or game counsels. Your life style should be based upon only what you are able to earn today not what you will earn tomorrow. Remember that if you are spending tomorrow’s income, you are going to have a much lower life style tomorrow than you enjoy today with tomorrow’s income.
While supporting your life style is a horrible reason for debt, there are some very powerful reasons to take on debt, even very large amounts of debt. Good debt is used to leverage savings, skills, talents, and ideas into opportunities for greater return. But even here you must start with your own saving which you have accumulated by living on less than you earned. Borrowing to begin or expand a business is the best type of debt you can have. You still need to be careful that the income generated by this debt is sufficient to service the debt and the terms are manageable within the context of your business.
As far as borrowing for a home goes, this can be almost as bad as borrowing for life style. It is very easy to purchase more home than you really need and end up with a mortgage which destroys your credit for years to come. If you do buy a house, remember it is very expensive to sell it and if you don’t plan on living there for at least 10 years don’t do it! If the real estate market turns on you, you may not be able to sell it at all (just ask your neighbors). If you need move to relocate to a better job market you would be out of luck. In addition to the risk of owning a house you also have the lost opportunities that your down payment represents. What else could you do with that money which would be a better idea than buying a house with that money?
Your mother and father have learned these lessons from personal experience and from watching the outcomes of our friend’s decisions. Life is much simpler without debt so be very careful before you take the plunge.