Labeling Debt To Make It More Palatable

By: Roshawn Watson

Sometimes facing reality is no fun. Many people realize the implications of being indebted: their debt steals their income and often their lives. They work to make the bank more prosperous but are barely treading water themselves. In general, their money goes towards liabilities and expenses. Wealth-generation may be the goal but is not evident by looking at their financial statements. As a coping mechanism, many people have decided not only that remaining in debt is not that bad, but to refer to such debt as "good." I'm not buying it. Are you?

Consumer Debt Is Consumer Debt
I think many people are fine labeling credit card debt as bad, but we sometimes have an artificial hierarchy with respect to other debt. We elevate student loans and mortgage debt as sacred. After all, we need an education and to live somewhere. We justify car notes because we need to get to work. First, there are ways to get an education, purchase a car, etc. without debt, albeit they are less pleasant. Also, your income statement doesn't really care about these distinctions; all it knows is that money spent on these things is money that isn't going towards your financial solvency, independence, comfort, and wealth. I wholeheartedly believe in the vast majority of situations, the labeling is immaterial and should be treated as such. It's debt and should be avoided and/or paid off. The main exception is that it is reasonable to continue retirement investing while paying off a mortgage. It's really that simple.

Home Mortgages Are Different
Some feel that mortgages are a different beast. They argue that while the mortgage balance is a liability, the value of the home is an asset. That's true, but value is subjective and becomes most relevant upon selling an asset. This is why home equity is increasingly not being included in surveys, such as the annual World Wealth Report, which defines high net worth individuals as "those having investable assets of U.S. $1 million or more, excluding primary residence, collectibles, consumables and consumer durables." Until it is time to sell, the concern should be how the asset is impacting your cash flow and for how long. After all, your income is your most powerful wealth-building tool. If it is obligated via a mortgage (or consumer debt, property taxes, maintenance costs), then you are losing valuable opportunities to invest and for your investments to grow.

Convince people that debt is good
Even if we consider the merits of "good debt," most debt doesn't qualify. If the term "good debt" is legitimate, I believe it would best refer to debt that is producing income now. For example, perhaps if you are earning a significant income from your debt and your leverage ratio is very, very, very small: meaning you can write a check tomorrow and be out of debt, then perhaps you are in debt that some would refer to as "good debt." This is a very conservative view of debt and obviously less preferable than avoiding debt altogether, but I would argue labeling debt that benefits your income statement as good is at least understandable and possibly defensible. However, I fail to see the validity of classifying debt resulting in negative cash flow (before or after accounting for depreciation) as good. I seriously doubt those who have achieved significant wealth would view such behavior positively. After all, 75% of the 400 richest Americans (Forbes 400) believe "the best way to build wealth is to become and stay debt-free." In other words, it is hard to get ahead financially espousing liabilities as assets, good conscience or not. Whatever benefit that is achieved by debt is more than offset by the risk assumed by the borrower. Using debt for investments or businesses puts the borrower at risk of making more mistakes and for the implications of mistakes to be magnified. Indeed, if you looked at your risk-adjusted rate of returns, borrowing money, even for these purposes, would not appear so casual.

If you don't eliminate risk, at the very least minimize it. I was delving into the finances of a big proponent for people building wealth by keeping "good debt." First, he recommends having at least a full year's salary (not expenses) in cash (not equity). He also keeps at least a 75% equity position in his primary home and could pay off the remaining 25% at any moment. Additionally, his income exceeds his expenses (including his debt obligations) by over a 12:1 ratio. Next, he recommends that every real estate deal must yield positive cash flow, from day one. If I didn't know any better, I would say he sounds downright conservative financially, despite shocking statements like "I'm rich because I'm deep in good debt."At the end of the day, proclamations about how you love debt and are rich because of it may be useful to sell books and garner media attention, but clearly being financially-conservative, solvent, and liquid has kept the foreclosure wolves at bay. Generally, anyone who has any sort of longevity in real estate or business cannot remain chronically over-leveraged.

Concluding Thoughts
Spare me the moral posturing or the detailed theoretical calculations telling me why debt is good please! Even the "good debt is alright" gurus don't really drink that kool aid (or they don't last). It's not that I'm mad at you for calling your debt good. I just don't believe you. We're still friends though, and because we are let me share something personal with you. By recognizing the debt for what it really was, a restraint on my cash flow, I was able to focus my efforts on eliminating it. It wasn't easy nor pleasant, but it certainly was simple... and relatively quick! Often the best advice in personal finance works out that way.

If you use your financial statements as your guide, I believe you may come to the same conclusion about debt as I have: debt is generally not a blessing to your finances.

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What Keeps You On Track Financially?

By: Roshawn Watson

As we gain ground financially, there will undoubtedly be temptations to give up or at least deviate from our chosen paths. Regardless of whether your goal is independence, comfort, or significant wealth, life happens. What keeps you on track financially when something disrupts your plan?

Financial Distractions
The unexpected car accident...the newly identified roof leak...the surprise orthodontics bill. There are many ways to derail a budget. On a daily basis, we are constantly assaulted with opportunities to ruin our finances and ultimately destroy our good habits. Nonetheless, whereas some people are able to resist financial distractions and stay (or quickly get back) on course, others become overwhelmed. If you have ever aggressively paid off debt (i.e. becoming debt-free) or quickly saved up a significant sum, the focused intensity and exhilarating momentum involved in achieving such a goal alone can be enough to keep you on track.
However, after you have achieved such "quick" successes, maintaining your discipline can become the biggest challenge in long-term wealth building. In other words, once you take the temporal blinders off, it's easy to get distracted by "shiny toys" and "doodads." In fact, part of the motivation for paying off debt, for some people, is so they can feel comfortable "living a little." How does one know whether it's too much though?

Short-Term versus Long-Term Goals
Your time horizon in receiving the benefits of your labor matters with respect to maintaining discipline. For example, if someone told you that you would NEVER get to experience any rewards, but you should still donate your money because it is the "right thing," would you participate? I would argue many people wouldn't. Let  explain, even if the only reward that you get is gratitude, knowing that you made a difference or spiritual enrichment, that's more than enough  motivation more millions of people to participate. Many charitable organizations realize this simple fact, which is why they constantly trying to communicate with their donors regarding the benefits and implications of their giving. However, if there is no clear benefit, it's hard to make the case to contribute for many. Of course, not everyone is like this though. Some people are sadistic, glorifying and cherishing self-deprivation. If that's how someone is wired, it's fine. However, it is important to realize that such people are in the minority. 

Delayed gratification and no gratification are very different for most people. This is one of the reasons why I always discuss paying off consumer debt QUICKLY. As painful as it is, financial counselors say people tend to have more success when they temporarily delay fun while paying off debt rather than trying to do it all at once. Many people can put up with a lot of unpleasantness for a short period. Note, wanting to realize some fun, even if it's in the future, is not being childish. It's childish to ignore the need of having some fun, just as it is childish to want to play all the time. The problem arises in reconciling your need for fun with your financial situation. Balance is key.

It can't ALWAYS be about living for tomorrow!

What Keeps Many People On Track
One of the most powerful tools to keep your family on track is to have a plan. Short-term and long-term budgeting for investments, education, paying off the home, giving, maintenance and repairs, and even fun can spare you a lot of grief. Remember the old saying: failing to plan is planning to fail. There's so much truth in that statement. Budgeting is perhaps one of the most underutilized methods of hitting your financial goals. It's just as amazing to see your future on paper, as it is motivating.

Along that vein, visualizing your future is one of the best ways to birth longevity to your plan. In your "mind's eye," if all you can see is scrimping and saving, then I doubt you will feel motivated to continue for too long, regardless of how you rationalize the virtue of your efforts. However, if you see a life with no lack, an ability to give like never before, and enough resources to accomplish your life's work, then that leased BWM seems a lot let appealing and you consequently stay on track.

Another way people stay on track is to know their weaknesses AND develop strategies to overcome them. Study yourself as your greatest enemy thus becoming your greatest friend. If you can't go to the shopping mall or electronics store without spending way more than you have for such purchases, why torture yourself? One way to apply this is through the miracle of automation. Eventually, we tend to be the humans that we are, and as such, it's somewhat easy and predictable to lack financial-discipline if we don't set up systems to keep us on track. If you are one who cannot stick to a plan on your own, make it easier for yourself. For example, consider automating your investments and savings. Also, add some accountability to your life: interact with like-minded people, and use your network as a support system. This could mean joining a forum, creating a mastermind group, or creating your own support network. Discipline is unnatural anyway. We're creatures of habit...not discipline! One way that I honor this principle is by not allowing certain foods in my house. That way, I'm not nearly as tempted to eat badly, as I would normally be.

Check your allocation. Does your budget pass the reasonableness test? It's not normal for a family of four to only spend $200 a month on groceries and never do any traveling, so why budget as such, especially if you have some flexibility. This isn't about making a budget for the perfect month. That's ineffective at best and demoralizing at worst. Budgeting is about identifying the resources your family has available and properly allocating them towards corporate goals you deem valuable.

These are some of the best ways to I think one can stay on track, but how do you make sure that you hit your financial goals?

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The Impossible Question: Just Who Is The Middle Class?

By: Roshawn Watson

The term "American middle class" is universally familiar but devilishly elusive. Incidentally, recent research has illustrated just how controverted this issue really is. There are several hypotheses, theories, and confounding factors pertaining to defining the middle class, and a long history dating back to a aristocracy and nobility. Let's explore the impossible question: just who is the American Middle Class?

Everybody Claims To Be Middle Class

Clearly attitude, not income, is most relevant in defining the middle class in America. According to a recent survey (yes, there are limitations to survey data) by the Pew Research Center, nine out of ten people in the US believe they are "middle class." Here's the breakdown: approximately 50 percent believe they are simply "middle class", 18 percent claim to be "upper-middle class," and 21 percent are "lower-middle class." Only 2 percent label themselves "upper class" and 8 percent call themselves "lower class." Demographically, the self-described middle class ranged the entire spectrum of the population with no clear age, gender, marital status, racial, social, or political biases. In short, just about everyone claims to be middle class.

Thus, it should no longer be a surprise that a couple making $70,000 in Northern California claims to be solidly middle-class whereas another couple also living in the same part of Northern California making $140,000 a year would call his family "nowhere near what you would consider middle class"  partly because they see their contemporaries making $200,000.  Even a couple making around $50,000 a year living in Boston claims to be middle class.

• Note, in the case of the couple making $140,000, he says they are not middle class because of their  mortgage debt, their two children, 1 car payment, and a separate home loan. Fortunately, they are able to save and invest 25% ($35,000) of their income though.
• The couple making $70,000 is middle class because they are able to take several trips a year, one of them works outside of the home part-time, and they expect to be able to fund their child's college. They bank about 15% of their gross.
• Of course, I've previously referenced the Parnell's: the couple earning $260,000 who state (their) "family's needs are met, but (they) don't have a load of cash to cover wants...we were just good old middle class."

Regardless of rationale or motivation, the phrase "middle class" has proven to be as ubiquitous as it is divisive because it means different things to different people. It appears to be less about wealth, income, and lifestyle and more about opinion and perhaps social status. This shows how people view the middle class on a sliding scale: regardless of their income, they're apart of it. However, it has not always been that way.

"Middle Class" Background and Current Cultural Relevance

Middle class used to be the intermediate social class between the peasantry and nobility of Europe. Economically speaking, the middle class referred to someone with so much wealth that they could rival the nobility. Thus, in today's dollars, that would make multi-millionaires and billionaires the true middle-class and everyone else, with lower wealth, the working class. With this perspective, the words of Sean Parker have greater meaning!

Sean Parker: You know what's cooler than a million dollars?
Eduardo Saverin: You?
Sean Parker: A billion dollars. (From The Social Network, 2010)

Do you want further proof that a million dollar net worth is becoming a standard expectation of the middle class? Consider that the old million-dollar standard is now often touted as a minimum that should be invested for retirement. In fact, home equity is increasingly not being included in surveys, such as the annual World Wealth Report, which defines high net worth individuals as "those having investable assets of U.S. $1 million or more, excluding primary residence, collectibles, consumables and consumer durables." Moreover, a recent Market Watch article suggests that a million dollars might not even buy you a house in one of America's top 10 most expensive cities for real estate. In fact, one business tycoon said if your true net worth is between $2-$4 million, then congratulations, you are now a proud member of the "comfortably poor." Remember, over two-thirds of millionaires have a net worth of $2.5 million or less. One would need $4 million in cash today to have the same purchasing power of $1.5 million in 1980.

With this as a frame of reference, it is easier to see why many higher income households don't gravitate towards the "upper class" label. Economically, there is a difference; from a purely capitalistic standpoint, many would not qualify for even the "middle-class" label.

Is the Middle Class Shrinking?
The answer to whether the American middle class is shrinking depends on your definition of what is the middle class. If you refer to middle class from a sociological standpoint, one could make the case that it is growing. For example, the number of people who typically have a college education, own a family house, and hold a managerial or professional post is increasing. Also, several people who are blue collar workers also consider themselves middle class.

In contrast, when you look at economics, the data may lead you to a different conclusion. The richest 1% of U.S. households had a net worth 225 times greater than that of the average American household in 2009 (Economic Policy Institute), despite the average net worth of wealthy household tumbling 27% to about $14 million (between 2007 to 2009). The average family's net worth plunged 41% to $62,200 from 2007 to 2009. Biases aside and regardless of whether you dispute their exact numbers, I do think that many would agree that the gap in wealth between the richest Americans and the rest has grown. Moreover, the wealth of the richest families in America is increasingly becoming disconnected with the income of American workers or the fate of the economy due to technological advances, globalization of the workforce and investments. While I don't mention this to make the case for wealth-redistribution, this is relevant to defining the middle-class because so much of its meaning rests on "how people feel." I'm referring to the relative-income (or wealth) hypothesis: your neighbor's paycheck (wealth) is as important as your own in determining how you view your place on the economic ladder. Since the upper end of the distribution is rising faster and further than in the past, it's easier for those in the middle to feel like they're falling behind.

What Does This Mean?
I conceded earlier that this may indeed be an impossible question to answer universally because it's so subjective, among other things. Perhaps one of the most pragmatic definitions for the middle class is: having roughly a third of your income left for discretionary spending (i.e. after paying for basic food and shelter). This would allows families to buy consumer goods, have adequate health care coverage, own vehicles, own a home, invest for retirement, provide for their children's education, take vacations, and not live from paycheck to paycheck.

If one has a reasonable income and cannot accomplish these goals, then perhaps debt, pricey real-estate, and high expectations could be the culprit. One thing is for sure: this debate will continue for a long time to come!

Tell me: How do YOU define the middle class?

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Like It on Facebook, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

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How Would YOU Retire In 10 Years Round Up

By: Roshawn Watson

Compound interest is a wonderful thing! With a relatively small amount of money invested, you generate sizable wealth provided that your rate of return is reasonable and your time-horizon for needing the money is sufficiently long. Indeed, Albert Einstein has been quoted saying "the most powerful force in the universe is compound interest." For example, if one invested $480 a month (about the size of the average car payment in North America) for 30 years and gets an 8% return, he would have $1.2 million, even though only $221K was invested. Most of the portfolio would be compound earnings! Clearly this uses the power of appreciation to your benefit.

While the value of compounded interest is obvious, it's clearly best-suited for a long-term strategy to building wealth. If your time-horizon for retirement doesn't allow you to reap the maximum benefit of compounded interest, here are some additional considerations from around the blogosphere.

• Money Reasons wrote about getting money from your portfolio now in the form of dividends. Remember, dividend income is typically tax-advantaged income, even if it is not in the form of a 401K, 403b, Roth IRA, etc. Additionally, by receiving part of your total return in the form of a yield, you have hedged against the immediate risk of your paper assets decreasing in value. Alternatively, do you think it would be better if you invest in companies that do not pay a dividend but increase in value astronomically (i.e. Apple or growth funds)
• Krant Cents addressed taking on debt to increase a competitive advantage for a thriving business. When I hear or read about debt, I simultaneously think about risks! I think my risk tolerance has forever been warped in this capacity, which is not a bad thing, but it means approaching problems in a different manner. Thus, while I would love to grow a business as quickly as it make sense to grow, I would not want to assume risks that could threaten its viability should things go wrong. However, most millionaires are business owners, and the income earned via a business can be structured in a tax-advantaged manner. (article link below under personal finance)
• First Generation American discussed horrible experiences with being a landlord, yet subsequently mentions that she did get an extra $15,000 for the hassle that she wouldn't ordinarily have had.The hassle factor of being a residential property landlord is clear and so are the rewards! Some try to bypass this completely by becoming a commercial landlord; however, the cost of entry and the amount of retained earnings (i.e. think emergency fund for when that expensive real estate sits empty) increases significantly in many cases. Additionally, many commercial landlords were hit pretty badly in the most recent economic downturn. A nice contract may not do much if the business tenant is going under. (article link below under personal finance)

Thought Question: How would your investment strategy change if your entire horizon for investing was 10 years? In addition to the aforementioned ideas: would you be pouring into small cap or emerging markets to get some tremendous growth? Would you become a minimalist?

Now, it's time to do the weekly Uncommon Money News and Yakezie Round Up.

Uncommon Money News and Round Up
In preparing to write my posts, I often come across noteworthy and sometimes bizarre financial and business news. Below are links to some of these sites. Enjoy!

To my readers: I am so honored by your support. Together, we are telling thousands of the importance of financial literacy. I absolutely could not do it without you: you are vital! Thank you sincerely.

Personal Finance (Yakezie and other PF bloggers)
Investment Fundamental at Retire By Forty - When Investing, Compounding interest is one of your biggest friends. Look at the numbers.

Financing My Dream at Krant Cents - Would you take out a loan to expand your business?

Blending Work And Pleasure at Money Reasons - All too often, we view our jobs merely as a source of provision. Is it reasonable that they can be so much more? I know I already linked to a different story earlier, but I couldn't resist this one!

How An Improved Economy Can and Should Affect Your Job Situation at Everyday Tips and Thoughts - here's one that caught me off guard. Kris connects the economy with your current job situation with a twist.

4 Worries About the US Economy at DIY Investor - What are the biggest threats to the U.S. economy today?

Bad Tenants Incidents and Lesson Learned at First Generation American - Completely read with shock about the Maggot Tenant.

You Only Know What You Know at 101 Centavos - How comfortable are you with dynamic data? Under what circumstances would you embrace the new

It's Pretty Bad When NJ Thinks It Has a Better Business Environment at The Biz Of Life - Find out which state increased taxes by 66% and whose businesses are the target of NJ's new commercials

Business
Ford Reports Largest Profit in 11 Years - Workers to get an average of $5,000. annual bonus

BP reports $5bn loss after Gulf oil spill

America remains by far the No.1 manufacturing country. It out-produces No. 2 China by more than 40%

Economy
Low-wage jobs dominated hiring so far in job market recovery.

Dow over 12,000

Nearly 11 percent of U.S. houses are empty

Entertainment Money News
Johnny Depp, Kristen Stewart Named Top-Earning Actor and Actress - Vanity Fair

Offbeat Money News
The Economist Argues That You Shouldn't Bother with an MBA

Only Two Years After Crisis, Wall Street Earns Record Pay

Carnivals that I've participated in:
Carnival of Personal Finance #294 Control Your Cash

Round ups that linked to posts from this site

• Don at Money Reasons - MR Review Avoiding Malware Edition
• Kris at Everyday Tips and Thoughts - Link Round Up - Getting Sick of Being Sick Edition
• Andrew at 101 Centavos - Axes Hammers, and Random Links
• Lazy Man and Money - Tax Preparation Weekend and Personal Finance Links

Surprising Trend In Mortgage Defaults

By: Roshawn Watson

Even more foreclosures are expected to occur in 2011 than 2010, according to Realty Trac. Interestingly, there's a new crop of homeowners that are defaulting on their mortgages, and it is not who you would initially expect. Homes without million dollar mortgages default at a rate of 1 in 12 whereas homes with mortgages in excess of a million default at 1 in 7. All of this raises questions as to the underlying contributors to this counter-intuitive observation.

Are They Really Rich?

First, it is important to realize that "all that glitters is not gold." In his book Stop Acting Rich, Thomas Stanley pointed out that typically luxury homes are a better reflection of one's credit burden rather than one's  accumulative wealth. The entire premise is that there are many people content with looking rich than actually being rich. Thus, they will over-leverage themselves and get into financial trouble. One of the challenges with these larger mortgages going into default is figuring out who is truly financially overextended versus who has strategically chosen not to pay their mortgages just because the values of the homes have gone south.

Remember, Teresa Guidice, from the Real Housewives of New Jersey, and her husband were able to borrow $11 million all on a reported income of only $79,000 (CBS News). They ended up filing bankruptcy, citing the collapse of a speculative "investment" as the precipitating factor (rather than borrowing to live an extravagant lifestyle that they couldn't afford).  Consider the $60,000 she spent on furniture and luxury goods just days after filing bankruptcy (NY Daily News). Her lawyer said new money had arrived. However, you have to wonder whether they were being truthful about their income being so low relative to their debt (essentially admitting they are financial phonies) or if they were simply getting their debt's discharged despite their ability to pay.

A strange reality is that people will go broke trying to look prosperous to impress people they don't really know and who really don't care. It's sometimes difficult to tell the real deal.

Just a Business Transaction 

Clearly, not all of these million dollar mortgage defaults are due to true financial hardship though. There are people who just don't want to pony up but have resources to meet their financial obligations. They are known as strategic defaulters. They willingly take the credit hit by failing to honor their commitments in order to mitigate their financial losses.

There are several reasons these jumbo mortgages are less likely to go into foreclosure. For example, the magnitude of money loss by "throwing good money after bad" is very large when considering luxury homes, despite the rate of decline being 3 times less than the non-luxury counterparts. Additionally, there are financial disincentives for all parties to foreclose on these homes. Not only are these homes harder to move on the market and more expensive to maintain, but foreclosures dramatically depress home values in a given area, which may adversely affects everyone's bottom line.

Thus, in these expensive areas, you get people living in phenomenal homes worth substantially less than what they initially agreed to pay, and the owners get fed up, stop paying entirely (either by choice or necessity), and are living in the home mortgage-free.

When it comes to real estate, these income-affluent are different. They can be just as ruthless as the bankers.

 

Honor

The fact that some of these homeowners view unfavorable mortgages as just a  business transaction gone bad that they can simply walk away from raises serious ethical issues. Obviously,  capitalism operates on trust between parties, so as trust eroded, it makes it harder for people of moral integrity to make legitimate deals. Clearly, there is also well-deserved outrage with big banks receiving tax-payer subsidization through bailouts; thus, some feel entitled to make the banks pay. This is a weak justification, as two wrongs don't make a right, yet it does add some texture to the issue. Nonetheless, there is real honor in meeting your financial obligations, as it indicates that maintaining your good name by respecting your commitments transcends all the other things that you could be spending your money on. Making strides towards to do so, especially in adverse situations, reflects maturity of character, which  goes well-beyond the financial sphere.

I'm sure anyone who thinks of a poor family being evicted while those with the ability to pay are decidedly abrogating their responsibilities while living in luxury would rightfully be upset. In a 2009 conference, a Kellogg Business School professor discussed how his 26 year old daughter was in the process of purchasing 200 homes in the Chicago Southside at $3000 each, which had previously been occupied by poorer people with mortgages over $100,000. People made similar investments in Detroit around that time.  The unfairness of this entire situation, including the erosion of values, is tragic beyond words. It's one thing to be forced into foreclosure, and it's something different entirely to choose to go into foreclosure because you no longer like the terms of your agreement.

God help us all if honor becomes only synonymous with poverty!

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

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