Good Habits for Financial Health – Part 2 of 3

  • Don’t confuse wants with needs
  • Manage debt carefully
  • Understand different types of debt and what their risks are

 

Don’t Confuse Wants with Needs

People don’t save as much as they could. What we need is simple, but what we want is often far more exciting and complex. When we mix wants with needs our ability to save diminishes.

We currently spend an awful lot of our income on luxuries, not necessities. In Figure 1, you can see that people in the highest income bracket spend approximately 65% of their income on luxuries. That’s fine since they have money to blow.

But, notice that people in the lowest 20% income bracket spend about 40% of their money on things they don’t need. This means that people have far more capacity to save than they give themselves credit for; they need to make saving a priority and create the discipline to save.

Manage Debt Carefully

High debt damages long-term financial security. Spending money on things that are not necessary is part of what is leading to higher consumer debt levels, and an increasing number of people are retiring with debt.

Once you are debt-free, you have a lot more financial flexibility, so manage debt carefully.

There are different types of debt, of course; some more evil than others. (See Figure 3)

Mortgage Debt

Most people are not going to be able to buy a house without taking a mortgage, so manageable mortgage debt can make sense. Unfortunately, we are seeing more  people take on excessive mortgage debt. This is difficult to sustain, and it’s important to understand the true cost.

Housing prices are increasing, particularly in the major cities. In the example in Figure 3 you would need an income of about $100,000 just to make mortgage payments. This obviously defers savings because if you’ve got this kind of mortgage for 25 years, you’re probably not saving a lot. And, if one person in the household loses their job, or interest rates rise significantly, the financial strain of an excessive mortgage now becomes a crisis.

Since we can’t control the high cost of housing, we need to ask ourselves, “What do I need in a property?” not, “What do I want in a property?” You don’t want to jeopardize everything else in your financial life trying to maintain a house.

Vehicle Loans

Most people, at least when they’re younger, aren’t going to be able to buy a car without taking out some form of loan. Short-term vehicle loans, i.e. three, or even five-year loans, can be manageable. But, if you take out a seven or 10-year loan, you’re getting into a rolling car lease. In seven to 10 years, the car will be old and the debt you still have against it may very well be greater than its value! And, you need a new car! People who lease their car by incurring rolling debt drastically reduce their ability to save over time.

Credit Card Debt and Consumer Loans

Consumer debt and credit card loans are the ultimate evil because of the interest rates that are charged on those. In the example in Figure 4, you can see how an original consumer debt of $10,000 could end up costing you over $16,000. That’s a 60% premium!

We have increasingly become a payments-based society. We continue to escalate borrowing until payments reach a certain dollar value. Debt levels are skyrocketing and household debt has more than quadrupled in the last 30 years. What’s worrisome is the fact that the amount of people’s income that’s going to paying down debt has only gone from 12% to 14%. (See Figure 5)

Interest rates are only slightly off of 30 year lows, so people are borrowing more.   In Julie Brough’s view, people should use a low interest rate environment as an opportunity to pay down debt faster, rather than letting it accumulate back up to a bigger proportion of their overall income.

 

View Good Habits for Financial Health Part 1 and Part 3

In February 2019, Julie Brough hosted our first webinar. The topic was Good Habits for Financial Health. Video of the entire webinar can be found here.

Please note this presentation was designed to provide general information only. It should not be construed as advice or considered a substitute for personal advice. Please consult your adviser to determine whether the information in this presentation is applicable to your personal situation.