WE all seek refuge from a scary world of escalating prices and complexity. How may we accelerate our journey from where we are to where we hope to go?
To improve our lives, there are several sound financial planning steps we may take. Three of those are:
1. Generate consistent cash flow surpluses through wise budgeting to accumulate savings;
2. Channel a portion of savings into diversified investments; and
3. Utilise both available cash flow surpluses and excess savings to pay off damaging debts.
If you crave additional knowledge, you're welcome to read these two recent Money Thoughts columns:
1.www.nst.com.my/lifestyle/sunday-vibes/2022/06/808204/money-thoughts-boos... and
2.www.nst.com.my/lifestyle/sunday-vibes/2022/07/812193/money-thoughts-focu...
…for my perspectives on Steps 1 and 2.
Take heed of ways to build a rock-solid asset base that will pump out passive income for you over the long haul.
HARNESSING FINANCIAL RESOURCES
Today we'll examine Step 3 to harness available financial resources to eliminate irksome or possibly tolerated liabilities. Our liabilities or debts usually rob us of future wealth and always chip away at our peace of mind.
At its core, a liability is a debt we owe today, which we'll repay with future income. (Note: I'm NOT writing for parasitic deadbeats who borrow money with no intention of ever repaying it.)
The debts we sit on today, hopefully accrued in good faith, were accumulated in the past to enjoy a benefit like a coveted good or service long before we could afford to pay for it in full.
Our entire global financial system is built upon a foundation of credit expansion.
When the total credit extended to governments, businesses and households in any particular country rises, legitimate lenders there then enjoy growing profits if the fraction of loan defaulters within that nation remains manageably low.
Ballooning profits of FIs (or financial institutions like banks) are major contributors to most countries' gross domestic product (GDP, or the value of all final goods and services transacted within national borders per unit time, typically a calendar year) or GDP calculations.
A country's economic health is seen to improve if its total loans growth is healthy. Okay so far?
Yet each time a person borrows more money to fast-track his or her enjoyment of some goods or services, like a car or a vacation, before amassing all the cash needed to pay for it in full, there is an element of laying claim to future wealth to pay for a past pleasure.
How many times have we layered multiple charges onto our overused credit cards with little thought of how to repay our utilised portion of credit, in full, before the monthly due date to avoid paying prohibitively high interest charges?
Some readers will say "never"; some "sometimes"; and others "too often".
UNDERSTANDING HOW IT WORKS
There are two important attributes of credit cards:
1. Convenience; and
2. Credit
Those who use their cards solely for the convenience of not having to carry too much cash, and who never spend more than they have and so never use the revolving credit facility that incurs a steep price, are in great shape.
Others who utilise their credit cards because they spend more than they have available for an expense will end up paying interest charges that add up, and thus, hurt their ability to accumulate long-term wealth.
This is easy to understand when we consider three typical interest rate ranges that apply to our regular monthly and occasional windfall cash flow surpluses:
1. Bank savings — perhaps plus 0.1 to plus 2.5 per cent a year earned (a form of passive income inflow);
2. Portfolio investments — typically up to, say, plus eight per cent a year earned over the long haul, though it can be lower, even negative, during market contractions, or higher during euphoric bull runs (in total investment return inflows comprising annual yields and per unit capital gains); and
3. Debt repayments — that might carry annualised percentage rates (APRs) ranging from, say, four to 20 per cent a year (incurring cash outflows).
There are two categories of debts: good debt that has the potential to make us richer over time, and bad debt that will make us poorer.
For emotional stress reduction and financial stability enhancement, do embark upon a programme of total debt eradication.
In all such endeavours, priorities must be set. We should line up all our metaphoric ducks in a row before we pick them off one by one.
SHOOTING THE DUCKS
The first of those "ducks" should be the bad debts that make us poorer with every passing year. And the best ways to pay them off are to, first, ensure that we have sufficient savings to cover short-term needs and potential emergencies. Second, commit to a steady programme of wealth accumulation through regular, diversified investing. And third, utilise a portion of available monthly cash flow surpluses, excess savings and investments to permanently repay bad debts.
Each time you fully repay one debilitating bad debt, commit to never taking on another such loan. If you take that commitment or promise to yourself seriously, you'll sequentially eliminate all the bad debts that have been sucking your economic lifeblood the way vampires extract human blood in horror movies.
Celebrate each time you make progress. But — and this is crucial — don't pay for your celebration with borrowed money.
© 2022 Rajen Devadason
Rajen Devadason, CFP, is a Licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).