More Back to Basics

Our topic last month was getting back to the basics of investing. This month I’d like to continue to focus on that same topic. Let’s start with a Net Worth statement. We all have one. Your net worth is simply your assets (what you have) minus liabilities (what you owe). An excellent net worth, regardless of how much, is when you have assets with little or no debt. That is a big factor in determining financial independence. Unfortunately we are living in a time when it’s okay to not only have debt, but to have a whole lot of it. It seems to me that a good part of our economic growth the past few years comes from us being able to get more stuff because we are able to borrow more. So although our assets continue to accumulate, our net worth statement as individuals has not gotten any stronger. Rather it has likely been getting worse. I’m not against having credit because we all need it, but we need to learn to use it wisely.

Older generations lived the old fashioned way when it comes to finances. Those who grew up in the depression had sound financial principals instilled in their minds because they had to. They were taught to work hard, save money then buy “stuff”. Fast forward a generation or two and we just keep buying more stuff and are plenty willing to pay for it for many years. My last article focused on the benefits of compounding when you invest. Financing our purchases over many years shows how compounding can work against you when you buy on credit. The banks get all the benefit of the compounding.

The most important “stuff” I am referring to in this article is your home. That is most often the largest purchase someone will make in their lifetime. We have been hearing about the housing crisis in the news of late. The reason we are in this situation today is because too many people were able to buy more home than what their income allowed. Buying a house can be an extremely emotional decision. Most want more than they can afford. Enter the banks who were more than willing to take advantage of those emotions and lend to those buyers. Many of those loans should have never been made. Then to make matters worse, many of those loans were subsequently sold thereby creating a disconnect between the risk assumed by the original lender and the current lender. This made it even more attractive for lenders to take on risky loans since they could turn around and sell them.

We can argue all day who is to blame for this mess but in the end the homebuyer should fully understand the risk and commitment of mortgaging a home. When I read Dr. Tony’s Corner last month regarding the spring cleanup around our neighborhood, I thought he hit the nail on the head. We are grateful for all the wonderful people that did the cleanup but in the end WE are all responsible for a clean neighborhood. We are to make good decisions – don’t litter, keep your lid on your trash can, etc. So is it that WE are responsible for making our own financial decisions. We need to get back to the basics of good old fashioned planning. That means work hard, save at least 20% for a down payment, then buy a house (or anything for that matter) that you can afford without stretching. Cheers to having a stronger net worth statement.