Tuesday, May 31, 2011

The 110% Solution

No matter how much you make, or how little, the secret to happiness is to spend less than you make.  Sadly, few do this.

The other day a friend came by.  They had an intractable problem and asked for my help.  "You're good with money," they said, "Can you help me figure out all these bills?"

Their problem, as it turns out, was not all that difficult.  Over their entire lifetime, for every dollar they made, they had been spending a dollar and ten cents.  They had lived beyond their means for decades, and now it was all coming home to roost.

For many folks, the idea that you can live beyond your means seems like defying the law of gravity.  "How can I be living beyond my means?  After all, that is financially impossible!"

Oh, but it is possible!  And you can live on 110% of your income for decades, even, before it catches up with you, in a very big way.  How?  There are a number of ways people do this - and none of them do it consciously.  People live beyond their means all the time thinking they are being fiscally responsible.  After all, they get free airline miles on their credit card, right?

Wrong.  What ends up happening is a lot of small actions that end up causing trouble, over time:

1.  Cashing in Equity in the Home:  This was very popular in the last decade, when home prices skyrocketed and people could take "cash out" in a refinance or home equity loan.  The consumer charges up a mountain of credit card debt (living beyond their means) and then pays it off with a home equity loan.  Their credit rating soars and new credit card offers come in the mail.

The immediate damage from this practice is not visible, as the consumer thinks they are being financially astute, as their cash-flow requirements have been reduced.  But all of this has been at the expense of their net worth which should have been growing, not shrinking.  So the "nest egg" of their home is robbed, over and over again, until by the time they retire, they have little or no equity left.  Or, if they really over-do it, they end up "upside down" on their house and end up in foreclosure.

2.  Failing to Save:  Many of those folks you see who have a new car, new boat, and lots of other toys and heavy spending habits also have nothing in the bank at all, in terms of savings.  To these folks, credit rating is everything, as everything in their lives - even their food - is financed.  So long as they have a job and make the minimum monthly payments on the credit card, everything is fine.  But one hiccup in the income stream, and whoops!

Again, the real damage may not be seen for decades, when the person retires and discovers what they should have known all along - that they have no money to live on, other than Social Security.  And even then, with their debt load, they end up in trouble.

3.  Credit Card Debt:  Credit cards are the easiest way to "live beyond your means".  You can charge up thousands of dollars a year on a credit card, and pay back maybe hundreds.  For the first few years, you are living large - spending more than you are making.  And the "monthly minimum payment" is pretty small.  They keep increasing your credit limit - or you get additional cards - until those monthly minimum payments suddenly balloon out of control (a rate jacking often precipitates this).

Again, this can go on for years before the piper has to be paid.  But if the consumer uses a home equity loan to pay off the debt, the process can be repeated, over and over again, for decades.

4. Bankruptcy, Foreclosure, Repossession:  Of course, once you get behind the 8-ball in a big way, the house of cards comes tumbling down.  The re-po man comes with his "stinger" to tow away your car, and the bank forecloses on your granite counter-top mini-mansion.  You may end up in bankruptcy, which may discharge some or all of these debts, or provide you with a low monthly payment on the balance.

For some, this is a wake-up call that they have been living beyond their means and the chickens have come home to roost.  For others, it merely is another stage in a continuing effort to live large.  Fresh from bankruptcy, they go out and spend even more - at even higher interest rates.  There is a whole industry devoted to the "bad credit" consumer.  Since you can't declare bankruptcy for another seven years, you are, ironically, a good credit risk.  They can take your kidneys, now, if you don't pay up! (figuratively speaking).

My friend's situation was typical of this pattern.  They had lived large for many years, taking equity out of their home in the process.  And what they spent it on was mostly crap - putting on the dog to impress others, donating huge sums of money to one of those fancy new churches, and other crap like that.  They saved nothing and spent more than they made.

When retirement was thrust upon them, they sold their house and with what little was left over, bought a motorhome.  As I noted before, the "full time" motorhome lifestyle is very, very expensive - more so than renting an apartment.  So they started running through what little money they had, and even bought a new motorhome, financing it on time.  Pretty soon, the repo man came and took the motorhome away.

Even so, they had enough in Social Security to live on comfortably.  But it was the same old story.  For every dollar coming in, they had to spend a dollar-ten.  And as I went through their bills, I realized that they had a lifestyle better than my own - cable TV, brand-name liquors, deluxe DSL service, and the like.

I pointed out 10 areas they could save money on - enough to bring their spending back down to less than their income.  And for each area of savings, there was some reason why they couldn't do it - fear, status, whatever.  They couldn't give up $100 a month for cable, right?  What would the neighbor's think, that they were poor?

But then came the punchline.  They wanted me to pay off their credit card debt, as a "loan" or to "help them out" so they could get a "fresh start".

But after 70 years, how many "fresh starts" do you need?

No matter what your income level, you can spend less than you make.  And in fact, when you take on debt, because of the interest you pay, you end up realizing less in income as a result.  The poor are poor not only because of limited salaries, but because they spend tons of money on interest and fees than you and I do not pay.

So a poor person starts out with less money, but then squanders half of that in payday loans, rent-to-own furniture, and other bad bargains that squander what little they have - promising them that they can have more NOW and pay later.  But all it is, really, is living the 110% solution - spending more than you make.  And over time, not only will you be poorer, you will be miserable.

If you can spend less than you make - 99% or less - you will actually be wealthier.  Yes, it means you may have to wait before you own that big-screen TeeVee or do without some things that your indebted neighbors have.  But in the long run, you come out far ahead.

But, unfortunately, if you do this, you will come out ahead, and your indebted neighbor will knock on your door one day and say, "Can you help me?  You're lucky, you've got money and I need your help!"