This is the full twentieth chapter of my book, and first on the subject of relationships, from my book Awesomeness: An Amateur Potpourri of a How-To-Guide.
See part 19: “Addition by Subtraction”, here.
Albert Einstein once opined that “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” [1]
Why would you want to be the one who pays it? In 2014, American consumers had a gargantuan total of $11.9 trillion dollars in outstanding debt. [2] Fortunately, most of this debt was on things like mortgages and student loans.
Still, Americans had $884.8 billion in credit card debt, which amounts to $15,609 per household. Which is a lot; especially given interest rates on credit cards usually start around 15 percent and then go up.
The principle of debt is rather simple: borrow money now and pay it back in the future, with interest. Thereby, anything bought with debt will cost more than it would have otherwise.
And, with credit card debt, it’s a lot more. Something you bought for $100 today will cost something like $115 next year. So incurring this debt better be worth it.
Now, not all debt is bad. The good kind allows one to make a return (financial or otherwise). So, mortgage debt used to purchase a house would often qualify as good debt because houses will, in the long run, appreciate. And you would still have to rent if you didn’t buy a house.
Debt for starting a business or purchasing an investment vehicle can also be good, since the goal is to make more than the cost of repayment. Student loans can be good debt, because we invest in our earning potential and or personal improvement and fulfillment (although the rapidly increasing costs of college seem to be making it less so). Other debts, such as those to pay for medical expenses, may not be good debt, but they are necessary debt.
But then there’s the bad kind, which is pretty much everything else. Virtually any debt on a depreciating asset or on something that doesn’t allow us to grow as individuals should be qualified as bad debt.
Patience is a virtue, and a lack of patience is quite expensive. It’s what economists call “time preference.” Effectively, an individual’s time preference is the relative value placed on a good now versus at some point in the future. The less time you’re willing to wait, the more you’ll end up paying because of the interest that will accumulate during that time.
Rent-to-own televisions, computers and even cars are simply transfers of wealth from the impatient to the patient. Bad debt means you are obligating yourself to work in the future to pay off whatever you’re buying today.
Why would you make such obligations? The work you do should pay for the present and to build a nest egg for the future, not just allow you to pay off something you’ve already used up.
What this all boils down to is perhaps the greatest key to success in life: the deferral of gratification.
In the famous Stanford Marshmallow Experiment, [3] young children were given the option of eating one marshmallow immediately or waiting 15 minutes to get two. Most children quickly succumbed to the temptation of the marshmallow and deprived themselves of the second. Only about one-third of them were able to hold out for the second marshmallow.
Many years later, the researchers evaluated how well the students did in life, and those who waited for the second marshmallow did substantially better than those who had not, on a wide range of factors. James Clear describes the results as follows,
“The children who were willing to delay gratification and waited to receive the second marshmallow ended up having higher SAT scores, lower levels of substance abuse, lower likelihood of obesity, better responses to stress, better social skills as reported by their parents, and generally better scores in a range of other life measures.” [4]
And similar results of this study have been repeatedly replicated. There is no question, the ability to delay gratification is universally regarded as one of the most fundamental skills a successful person can have. And, thereby, it’s one of the most important skills to nurture in yourself.
So the moral of the story is simple: Consumer debt represents the first marshmallow.
And yes, this isn’t the easiest thing to do given the smorgasbord of cool, new consumer products deftly marketed everywhere along with the massive amounts of money various companies spend in advertising. But it’s a temptation you must fight to avoid.
In the end, building a nest egg and having enough disposable income to do what you want in life involves saving money, not paying through the nose for things that will become all but worthless by the time they are paid off.
Even a new car loses more than 10 percent of its value the moment you drive it off the lot! [5]
The more bad debt a person has, the worse his or her credit score will be (and, the more likely he or she is to default), making it that much harder to acquire good debt and get it at a good interest rate.
Going into debt because there’s no other choice is one thing; otherwise, debt should only be used as an investment. I strongly recommend splitting debt into the good and bad categories and leaving the bad type for good. Make it a rule instead of a recommendation. Even auto loans should be avoided, if possible.
Bad debt, which includes virtually all consumer debt, leaves you running just to stay in the same place. Avoid it like the plague.
[1] Albert Einstein, “Albert Einstein>Quotes>Quotable Quotes”, Good Reads, http://www.goodreads.com/quotes/76863-compound-interest-is-the-eighth-wonder-of-the-world-he, Accessed May 3, 2015
[2] Tim Chen, “American Household Credit Card Debt Statistics: 2015”, Nerd Wallet, http://www.nerdwallet.com/blog/credit-card-data/average-credit-card-debt-household/, Accessed May 3, 2015
[3] “Stanford Marshmallow Experiment”, Wikipedia, http://en.wikipedia.org/wiki/Stanford_marshmallow_experiment, Accessed May 3, 2015
[4] James Clear, “40 Years of Stanford Research Found That People With This One Quality Are More Likely to Succeed”, JamesClear.com, http://jamesclear.com/delayed-gratification
[5] “Depreciation Infographic: How fast Does My New Car Lose Value?”, Edmunds, http://www.edmunds.com/car-buying/how-fast-does-my-new-car-lose-value-infographic.html, September 24, 2010
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