Monday, September 28, 2009

In Your 20s, riddled with "Bad Debt"

We are not born with knowledge or experience. The most important time to learn how to manage money is in our youth and our twenties, but if we don’t even know what we don’t know, then how will we know what we will need to learn? If that didn’t confuse you enough then keep reading!

I will outline strategies and money management skills that you’ll need with each of these levels. Ok, so you may be the exception to the rule, but it’s most likely that you are either in your twenties with:
(1) Bad debt (personal loans, credit cards etc) or
(2) No debt (some savings - see next article) or
(3) Good debt (mortgage, properties, geared/leveraged share investments-see next article).

(1)In your twenties with “Bad Debt”

What is a “Bad Debt?” Bad debts are any debts that are spent on consumables, items that are disposable, that depreciate, that lose value over time, that are just for fun, that don’t earn any income for you.

Don’t worry, this is a common scenario. You were either in school, college or university when you first discovered a world of credit. Unfortunately if you fall into this category, the debt monster is out of control. So it’s only $30/month, or $50/month or even $400/month for a car payment – you can afford it right?

What no one told you was that yes, you can afford it, but you shouldn’t have bought it because, for every $1 you borrow, you would have had to pay back a few dollars in return. That $25,000 car would end up costing you $35,000. That fridge you bought interest free 3 years ago for $800, once your monthly payments were finished, you ended up paying $1,500 for it. What a bargain, right? No one told you that the world was out to screw you when you were prime and ready to be taken advantage of.

So how to escape the crazy world of revolving credit and debtors chasing you for payment?

Budget by working out your income and your expenses. Budget- what an evil word. It’s dull and boring but it will shed light on your life. Plenty of budgets out there on the web for you to Google. Use pen and paper or spreadsheet, or a program – who cares how you do it, just do it.

All you really need to know is how much are you spending versus how much you are earning for each day, week, month, quarter and year. It's tedious but simple right? Start today, with a daily calendar and write down each time you actually spend on anything. Each time you pay a bill on credit card. Each time the bank automatically direct debit funds from your account. Day by day you will unwind the cause of the financial black hole that you’re in.

Write down all your income. Salary, wages, dividends, rental income, bonuses etc. You will need some basic maths skill in converting everthing to a daily, weekly, monthly, quarterly and annual basis so that you can compare expenses versus income.

If you spend more than you earn then you will have to cut back on your spending. Either that or earn more. Go read those books about living frugally and saving that little dollar, otherwise you will struggle your whole life, if you haven’t already.

You can easily cut back on any discretionary expenses. Any expenses that involves something you can control daily or weekly – eg eating out, groceries, entertainment, etc Cheaper mobile phone or internet plans are a few examples of descretionary expenses. This is not an article on how to cut back on expenses and live more cheaply. This article is how to manage your debt and bills in your twenties so if you want to pursue this option – read books on frugality and check other web blogs and articles.

Sort your expenses. Open up those bills. If you’re at this stage, you have a multitude of bills. Sort them out into categories. Utilities – phone, electricity, gas, water and mobile phone. Living – mortgage/rent, insurance, council fees/taxes and strata. Loans – mortgage/car/study/education/credit card loan/personal loan bills.

There is no point in investing until you have your debts and bills under control. Your most important bills are your mortgage and utilities. Lastly your credit card and personal loans- sort them out by interest rates OR by loan amount. You are going to focus on paying off one credit card/personal loan bill one by one until they are demolished. Pay the minimum on all of them except one bill.

That one bill can either be the one with the highest interest rate (smartest choice), or the one with the smallest balance (an emotional ‘feel good’ choice). Pick one.
Keep doing this and you will eventually be out of debt. It’s that simple.

Negotiate for better rates, for better deals and try to cut back on your expenses. You’ve organized all your paperwork, done the budget so what next? Start hunting around for low or interest free credit. Read the terms and conditions. If it’s beneficial, transfer or roll over your debt to this. Close off that old credit card/loan so that you don’t rack up new debts on it. This option is not recommended if you have poor financial skills. How can you recognize a better deal if you can’t calculate the pros and cons mathematically?

Can you stay at home with your parents? While others may scoff at this, you will be the one laughing when you sort out your financial life earlier than you could think was possible. It’s not smart to be paying rent to a landlord. Instead, if you have a great relationship with your parents, stay with them, help around the home, pay some of the household bills and start paying off your debt with the money that you save from not paying rent. Use this money to pay your debts and then save up a deposit to buy your own place.

If you have no choice but to rent
– then you need to downgrade to a smaller and cheaper place. Also consider flat sharing arrangements. By minimizing your rental expenses, sure you sacrifice some freedom and privacy but this will help you pay off those debts sooner and save up for your own place. Either way – it’s not smart to live in a flashy apartment, drive a flashy car and have a flashy lifestyle when you’re up to the eyeballs in bills, debt and loans.

Focus on your career or business. This will provide you with increased income and help you pay off those bills and expenses faster. It will expedite your ability to save and thus, invest for a better future. Increasing your income, savings and investments will give you peace of mind because you can’t always live day to day, pay packet to pay packet. If that isn’t important to you yet, then at least it will provide you with a way to save for holidays, trips and all those toys you want to buy.

Learn good money habits. While you’re young, sexy, smart and beautiful, you also have time on your side. Time for you to fix mistakes, time for any investments faltering to recover, time for your portfolio to recover, time for you to take some financial experiments.

Compounding interest will work either for you (if you have investments and savings) or against you (if you have debts/personal loans). Einstein is quoted as believing that ‘compound interest’ is the eighth wonder of the world. He’s one smart dude. If you're young, you have the power of compound interest at your beck and call. Be it's master, and it will serve you diligently and reward you with passive income as you progress on your investing journey.

1 comment:

  1. Bad debt is even worse than what you have to pay back. It does not include opportunity cost.

    That car bought for $25K on credit that costs you $35K is also $35K you could not use for something else.

    The long term cost of items like a car are horrendous. If you had an investment returning 10% pa, then after 10 years that $25K is worth $65K. So using $25K for buy a car means you LOST $65K. Thats what the car ACTUALLY cost you. And the car drops in value!

    Buying on credit is even worse. That $35K example means your opportunity cost is closer to $90K.

    All good reasons to buy bangers.