Sunday Vibes

MONEY THOUGHTS: Scrutinise good liabilities when managing debt

WE all know how things that are clearly bad can harm us. Yet there are certain ambiguous elements of life that are much tougher to assess.

We usually measure our economic success by our personal net worth. It's an excellent metric, as far as it goes. However, we should be careful of two considerations pertaining to net worth calculations:

1. We should never mistake our net worth — be it large or small, positive or negative — with our fundamental self-worth or value as a human being; and

2. We should drill beneath the surface listings of our assets and liabilities to scrutinise their compositions.

First, our net worth should never be equated to our self-worth because money is not the most important thing in life. But money does seem to affect every other facet of life of greater importance than mere material possessions; consider our health, fitness, education, level of culture or breadth of intellect.

In my previous Money Thoughts column titled Economic uplift through net worth enhancement, I wrote that "...if you crave to clamber up (the socioeconomic) …ladder, do three things:

1. Build up your monthly cash flow surplus by working harder and smarter;

2. Allocate your surplus toward savings and investments that make you wealthier over time; and

3. Attack the loans that are dragging you down."

If you'd like to read the whole column, do so at: www.nst.com.my/lifestyle/sunday-vibes/2022/07/816006/money-thoughts-econ....

Today, we'll zero in on point number 3.

GOOD LIABILITIES/BAD LIABILITIES

If our goal is to grow incrementally wealthier, we must elevate our net worth over the coming decades. This means gradually raising the numerical value of all we own minus all we owe today.

When we wisely opt to "attack the loans that are dragging us down", we will not just make scheduled payments on our loans but also try to add additional payments to accelerate the eradication of each loan within our debt portfolio.

Note: In this context "portfolio" means collection. For instance, I have a sizeable portfolio of comic books dating back to the 1980s when I worked in Silicon Valley in Northern California and shared a house in San Jose with a great bunch of guys, one of whom ran a comic book business. (Good times!)

Similarly, some people higher up the socioeconomic ladder than I am have portfolios of fine art, while many more of us on various rungs of this ladder have portfolios of saving, investment and debt instruments.

When we scrutinise our debt portfolio (or collection) of liabilities, we'll see they fall into two buckets:

1.Loans we've taken on to buy items or to engage in activities that end up leaving us poorer;

and

2.Loans we've incurred in a bid to gain wealth.

Many years ago, I learned about good assets and bad assets from several books in the vast Robert Kiyosaki Rich Dad, Poor Dad series. Kiyosaki taught his millions of readers that good assets make us richer by putting money in our pockets, and bad assets make us poorer by taking money out of those pockets.

The same is true for good liabilities and bad liabilities. Common examples of good liabilities would be a loan taken on to grow a viable business and a mortgage on a piece of brick-and-mortar investment real estate.

A bad liability might be a personal loan taken out to indulge in post-pandemic retail therapy or unpaid rolling credit card balances racked up to pay for luxury expenses like fancy meals and holidays we can't truly afford.

The cost of bad liabilities in terms of annualised percentage rates or APRs are usually higher than those of good liabilities. This makes it a no-brainer, most of the time, for us to pay down all bad liabilities first.

As we do so, we free up allocated cash flow for other purposes. For instance, we might elevate our lifestyle by using money previously channelled toward a stubborn credit card balance that's eventually hammered down to zero (yay!) for fun activities like additional date nights with our spouse or significant other — paid for by the extra cash. That's wonderful.

BOLSTER OUR FINANCES

But might I point out one truth most of us forget until we're caught in the maw of the next economic maelstrom? A so-called good debt, such as a mortgage on a shop-lot rented out to a restaurant, might become a bad debt that sucks the cash out of your life if another pandemic hits and the government re-imposes a draconian movement control order or if this unrelenting season of staff shortages forces your tenant to shutter her business.

Anything can happen in the future. When good things occur, we smile, acclimate to them and assume great times will keep on rolling. But eventually storms hit us again — hard.

The best way to protect ourselves from such economic tsunamis, temblors (earthquakes) and typhoons is to use available economic upturns to rapidly retire as many good debts as possible to bolster our finances.

We don't know what the next major economic crisis will be. And we don't know when it will slam into us or how long it will last. What we know for sure is that it will come.

Prepare yourself.

© 2022 Rajen Devadason

Rajen Devadason, CFP, is a Licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).

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