It’s rather amazing the lengths people will go to get a bargain. From cutting coupons, to driving across town to that store your friend said sold X on the cheap, to haggling over some trinket with a street vendor.
Yet, at the same time, most Americans spend more than what something actually costs because they buy it on credit. And it’s important to know that when you do buy something on credit, that’s exactly what you are doing; paying more for it than it actually costs.
In 2014, American consumers had an enormous total of $11.9 trillion dollars in outstanding debt. While most of that was on things like mortgages or student loans, Americans still had $884.8 billion in credit card debt, which amounts to $15,609 per household! And given that the interest rates on credit cards starts around 15 percent and goes up, that is a massive sum.
The principle of debt is simple: borrow money now and pay it back in the future with interest. Sometimes this makes sense. Sometimes it involves a great investment. But with consumer goods it basically never does. Something you bought for $100 today will cost something like $115 next year if bought on a credit card. And furthermore, consumer goods depreciate ridiculously fast.
Of course, not all debt is bad. The good kind allows one to make a return. So, mortgage debt used to purchase a house would often qualify as good debt because houses will, in the long run, appreciate. And you would still have to pay rent if you didn’t buy a house.
Debt for starting a business or purchasing an investment vehicle can also be good, since the goal is to make more than the cost of repayment. Student loans can be good debt, because we invest in our earning potential and or personal improvement and fulfillment (although the rapidly increasing costs of college seem to be making it less so). Other debts, such as those to pay for medical bills may not be good, but they are at least a necessary debt.
But then there’s the bad kind, which is basically everything else. Virtually any debt on a depreciating asset or on something that doesn’t allow us to grow as individuals should be thought of as nothing more than bad debt.
Patience is a virtue. Or perhaps we should say that a lack of patience is expensive. It comes down to what economists call “time preference.” Time preference is the value someone places on a good now versus some point in the future. The less time you’re willing to wait, the more you’ll end up paying because of the interest that will accumulate during that time.
Rent-to-own televisions, computers and even car loans are simply transfers of wealth from the impatient to the patient. Bad debt means you are obligating yourself to work in the future to pay off whatever you’re buying today. So why would you make such obligations? The work you do should pay for the present and to build a nest egg for the future, not just allow you to keep up on the hamster wheel.
In the famous Stanford Marshmallow Experiment, young children were given the option of eating one marshmallow or waiting 15 minutes to get a second. Most children quickly yielded to the temptation of the first marshmallow and lost out on the second. Only about one-third of the kids were able to hold out the full 15 minutes.
Years later, researchers evaluated how well these various kids had done in life. James Clear describes the results as follows,
“The children who were willing to delay gratification and waited to receive the second marshmallow ended up having higher SAT scores, lower levels of substance abuse, lower likelihood of obesity, better responses to stress, better social skills as reported by their parents, and generally better scores in a range of other life measures.”
What this boils down to is that the ability to delay gratification is one of the most fundamental skills a successful person can have. And, thereby, it’s one of the most important skills to develop in yourself.
And to tie everything back together; consumer debt represents the first marshmallow. Yes, this isn’t always the easiest thing to do given all of cool, new consumer products ubiquitously marketed everywhere. But it’s a temptation you must fight to avoid.
In the end, building a nest egg and having enough disposable income to do what you want in life involves saving money, not paying through the nose for things that will become all but worthless by the time they are paid off. Even a new car loses more than 10 percent of its value the moment you drive it off the lot!
Going into debt because there’s no other choice is one thing. But otherwise, debt should only be used as an investment. I strongly recommend splitting debt into the good and bad categories in your mind and leaving the bad type for good. Make it a rule instead of a recommendation. Bad debt, which includes basically all consumer debt, leaves you running just to stay in the same place. Avoid it like the plague!