Sunday, December 5, 2010

Horribly Bad Financial Decisions

Horribly Bad Financial Decisions

To succeed in America, you don't need to buy a book of investment "Secrets" or get involved in some sort of money-making scheme.

All you need to do is act rationally in an irrational world, and not make horribly bad financial decisions.
What sort of decisions?

Well the obvious ones, we've discussed here at length - the sort of bad bargains offered to the very poor and very young - payday loans, title pawn loans, rent-to-own furniture, buy-here pay-here used cars, 90 days same-as-cash, high interest rate credit cards, that sort of thing.

But middle class people make horribly bad decisions as well.  For example, I had a neighbor living in a home worth maybe $100,000.  Parked in his yard was a boat he paid $50,000 for, plus a pickup truck he paid $35,000 for.  And that was just part of his fleet of rapidly-depreciating internal combustion engine vehicles and toys.  He had more "invested" in vehicles than in his home.  And of course, nothing invested for his future.

That is a common trap for people working for companies, making "good money" (or so they think).  The temptation is to look at wealth as something you park on your lawn, for all the neighbors to envy.  But it is a false form of wealth - just an ostentatious display of borrowing power, not real assets that are owned.  And as I noted in my Upside-down boat, posting, often the owners of these nightmares can't sell them, as they owe more than they are worth.

Leasing a New Car, of course, is one example of a horribly bad financial decision that is made by a LOT of people.

And of course, the middle-class routinely gets snookered into credit card debacles, caught in a quagmire of debt due to high-interest-rate credit cards baited with frequent flyer miles, or cash-back bonus dollars or whatever.  Taking the bait for mere pennies, they sell themselves into tens of thousands of dollars of debt, convinced they are "saving money" on airfare in the process.

But even upper-middle-class people make horribly bad financial decisions, and end up poor as a result.  For example, selling off the house to "retire" to a depreciating RV.  They sell the home, spend a half-million dollars on a "Custom Motor Coach" to go RV'ing "full time".  Within a few years, the coach has depreciated severely in value, and the cost of living the "RV lifestyle" is easily 2-3 times what they spent in their paid-for home.  In a matter of just a few years, they have squandered half their estate.

There are cheaper ways to go RVing, of course.  Buying consumer goods that are far above your income level (like buying a home far above your income level) is one sure way to get into some serious trouble, financially.

And I've seen fairly wealthy people do fairly stupid things, like gambling, or getting involved in day-trading stock scams or the like.  Heck, even Chelsea Clinton's father-in-law is in jail for getting sucked into a Nigerian scam, and then bilking his clients to pay for it.  Smart people - wealthy people - but lured by the promise of easy money.  Making irrational decisions, basically.

Here on the island, a number of residents are making the biggest financial mistake of their lives.  The Authority has generously offered to extend our expiring leases by another 40 years - to 2088.  This is a good thing, as you cannot sell a property here, unless you have at least 40 years on the lease, as no bank will lend on it.  With only 38 years left, banks were shying away from lending, and it was starting to kill resale values.

Our new lease doubles the lease rates from $400 to $800 - a YEAR.  This is hardly a lot of money.  And as an incentive, for the first five years, the rate is cut in half (to $400, which was the original amount). Yes, the rates can go up over time, but not significantly.  Overall, it was a very generous offer.

Yet seven residents have said they will never sign this lease.  Another 20 have simply failed to respond.  I've talked to some of these folks, and you have to wonder if dementia has set in.  If they fail to sign the lease, they can still stay until 2039.  And they could renew the lease later - but based on property values, not on a pre-negotiated rate.  Leases signed after the first of the year could cost in the thousands of dollars per year.

Why does this make a difference?  When you go to sell  your property, the lower lease rate means a higher resale value.  People buy homes based on monthly cost, and if the least is several thousand dollars a year, this depresses the price of the home substantially.

Some of these oldsters say "Well, I don't care, I'll be dead by then!" which, like in my posting about reverse mortgages, is false logic.

Very few people die in their homes.  Maybe one spouse might, but the other will surely then sell or go into assisted living.  At that point, they will have to sell the home, and without the renewed lease, that would be hard to do.  With a renewed lease at a higher rate, the home will be worth less.

So it makes sense to sign these new leases, to preserve your property values.  And it makes sense to preserve your property values, as your property is an asset that you or your spouse will likely cash in before you die.

It is a shame that otherwise smart people are making such a huge financial mistake, out of sheer orneriness and stubbornness - or perhaps, as I say, incipient dementia.

Spend less than you make.  Put some  money aside.  Pay down and then pay off debt.  Don't buy a lot of consumer junk.  And try to make rational decisions in an irrational world.  These are not hard things to do, and anyone can do them, and it is never too late to try.  Do these simple things, and you will end up wealthier and happier.

Do the opposite, and the outcome is preordained - debt, poverty, and misery.