(I am thinking of starting a series on personal financial matters. I have seen enough TikTok and social media videos to recognize that a great many people are lost when it comes to personal financial decisions – and often make foolish choices and then whine about not having money on social media. This is just one random post on a personal financial topic.)
We once lived in an old neighborhood at the base of some hills. Our little neighborhood was old homes built mostly in the 1960s and into the 1970s.
Up in the hills behind us were new, fancy, large homes with views. This is where, as the kids would say, “the richies” lived. And it sure looked that way from the outside! Many also took international vacations each year, to exotic destinations! Must be super wealthy!
Oddly, nearly everyone on our old street with old homes was well off – but they didn’t look like it. Most of our neighbors owned their own small businesses – construction, vending machines, manufacturing, a sports gym, another construction business, an owner of a hair salon, a restaurant operator, a well-off retiree or two. They drove old pickup trucks some rode motorcycles.
To the outside world, this was a classic working-class neighborhood – not “the richies” who lived above us.
But – in reality – “the richies” above us, with their fancy homes and new cars were debt slaves – while the working class neighborhood had little debts and very ordinary lifestyles.
Wealth = Assets minus debts
But many came to believe that Wealth = Assets PLUS debts.
The latter looks like wealth – but is not. This is a trap many fell in to – buying stuff with borrowed money, rather than saving.
The shocking secret to wealth creation is you need to make more than you spend, and save and invest the excess. That requires making decisions, foregoing pleasures today (bought with money), and be willing to live beneath your means.
The opposite is to assume your present rosy economic situation will remain forever, borrow much, and make loan payments right up to your maximum income limits. This can work – until it doesn’t! Things that cannot go on forever, tend not to go on forever!
In the 2008-2010 Great Recession, our local paper ran a story about “repossessions” of cars, boats and other items on which the buyer had stopped making payments.
According to the news story, the typical person who had a vehicle repossessed was in over their head, in debt.
As one of those quoted said, the typical person losing vehicles had a 2,400-2,800 sq foot new’ish 2-story home, and two recent model SUVs in the driveway (bought with a loan), an RV trailer or similar in the side yard (bought with a loan), and often a boat (one in five homes in the area had a boat of some type) – all bought on debt.
Then, in the 2008-2010 downturn, one of the typically two wage earners in the home lost a job – and they could no longer make their loan payments. After a few months, creditors came knocking – and vehicles on whom loans were in default, were re-possessed.
Contrary to some of the memes at the time, most who lost their homes had taken on way too much debt to buy a lot of toys.
To avoid this – you must live beneath your means, save for future purchases, minimize debt when possible – and invest. That means putting money into things that gain value.
When you buy a new car, it loses significant value the minute you drive it off the dealer’s lot. A car almost never appreciates in value over time – but quickly loses value.
Real estate, on the other hand, generally increases in value – and represents a hedge against inflation. (Why does it increase in value? I would say one reason has been due to an increasing population, creating demand, and two, a large number of government regulations have made it more difficult to build new housing. This is likely by design as those in power push for things like this to benefit many, such as realtors, bankers and even politicians who get campaign donations based on “selling” access to regulations.)
Because real estate usually increases in value, buying a home with debt can make sense. Yes you are making loan payments and interest payments, but the capital appreciation of the home, and tax advantages, often make up for that – so you eventually come out head. Buying a rental property can do even better – if structured right, the rent payments pay the loan / debt expenses – and over time, you profit from the property’s appreciation.
Investments in stocks mean you become a part owner of a business. To the extent the business is growing and/or paying dividends from profits, your investment rises over time.
Compare that to borrowing money to buy a car or a boat – each of which loses value.
Spend money on toys today – and never accumulate wealth – or postpone spending and invest your excess income now.
Therefore, the “secret” to creating wealth is to
- live below your means
- save and invest your residuals (left over money)
- do not overspend on frivolous temporary pleasures (once spent, it’s gone)
- put money into assets that are likely to increase in value, over time
- use debt carefully – and primarily to buy things that appreciate in value over time (homes, creating a business)
- avoid using debt to buy toys – instead, save in advance and buy only once you have the actual assets available to make a purchase.
In the end, this is not really a secret – but common sense.
Yet, as many of us have seen, great many people do not understand these simple concepts.
