We are all inundated by financial advice no matter where we go. 3 seconds after going online you are yelled at by one financial guru to never go into debt for a depreciating asset. Then 3 seconds after that another guru is telling you that only suckers pay cash and you should always finance. What gives? They can’t both be right, can they?
As usual, asking the right question is vital to get the right answer. The question should be, who is this advice apply to.
Going through different stages of success has shown me that there are at least 4 different stages of financial security that that should dictate whether you should pay in cash or take out that loan. Each stage has different advantages and pitfalls to watch out for.
Gasping For Air
The first step is one familiar to younger kids and those that have grown up in poverty. You are barely making ends meet. In this stage it is likely prudent to not take any loans out that you do not need to and try to focus on increasing income. For some this means school, for some it may mean starting a business, and for others it may mean finding a job where you can work hard and move up the ladder. Taking out loans is just weighing yourself down in fees and it is extremely easy to get in a vicious cycle of overdrafts, late payments fees, and debt.
In For The Long Haul
So you have a decent career paying you a good wage that you expect to stick with the rest of your life. You make enough to put some money in retirement and also have a nice savings for a rainy day. At this stage, you may be in the best position to take out loans for your absolute biggest purchases (Home and cars) but try to use any other debt as transitory (Credit Cards paid off every month). Credit Card debt is good for no one and except for transitory purposes is a sign of living past your means. However it may not be a good idea to only buy a home and car that you can afford to pay off. You have a steady job and there is no reason to live in squalor when paying a little bit of interest can fast forward your living conditions decades.
You’re a big shot now. You just made it to CEO of a large company. Or maybe you started your own company and it’s raking in cash. You are bringing in WAY more than you can prudently spend. At this stage, you should be living reasonably but socking away as much as you can to actually become wealthy. Most people don’t realize that you can have a .1% income while still being far from 1% wealth. It takes a while to build wealth, and this is where you do it. If you are financially inclined, you can start looking at investing your money, but buyer beware. It’s much better to have cash not making any money than being greedy and putting all your money in risky investments that wipe your slate clean.
At this stage, while theoretically the optimal thing to do is start investing in long term portfolio’s, doing this may also not be realistically the optimal thing to do. If your investments will bring you 5 figures a year but your income is bringing you 7, your time may better be spend raising your income 10% than learning to invest prudently.
Ignore the guru’s that tell you only idiots pay cash and rich people take out loans so they can invest their money. Let them continue doing this for a few extra bucks, while you spend an extra few hours on your business and double those potential gains.
Nothing wrong with paying off your house and car here. If you aren’t making 4%+ on your money, then you aren’t beating what you lose in mortgage interest anyways.
Focus on your large income and try to stay debt free.
Riding into the sunset
So you sold your business and now have a big chunk of change, huh? Or maybe you have just been making good income from stage 3 for long enough that you have amassed a serious stockpile.
You may have finally made it to the stage where you need to seriously look at investing your money and start “thinking like the rich”. You have a big portfolio and interest can finally provide you with a good lifestyle in itself. On top of that, you have to stave off inflation! Don’t let other’s fool you, it’s not always an easy task.
But it is finally time that your portfolio can take precedence over other business. Fast forward and you are now making a decent return on your money. You’ve retired and started living off that yield. Or maybe you live off the yield and you continue working for enjoyment. Now is finally the time that it makes sense to start taking loans out for assets when it makes sense. Why say no to a mortgage for 2.5% when inflation this year is 3% and you can make another 6% in the market? When you know that you will alawys be able to make these payments, market fluctiations make no difference to you, and you will never be forced to sell….This is when it finally makes sense to think this way.