by James R. Peters

Financing Consumption: A Dangerous Proposition

By on September 7, 2013 in Budgeting, Credit, Financial with 0 Comments

Financ­ing is a pow­er­ful tool with long last­ing effects and should be care­fully delib­er­ated. Friv­o­lous spend­ing with bor­rowed dol­lars is a dan­ger­ous endeavor with poten­tially dev­as­tat­ing reper­cus­sions. Indi­vid­u­als, busi­nesses and gov­ern­ments (“IB&Gs”) must pri­or­i­tize needs, invest­ments and wants, and uti­lize financ­ing only when appro­pri­ate and necessary.

IB&Gs rou­tinely pur­chase goods and ser­vices, each time hav­ing to decide whether to pur­chase out­right or bor­row money to pay for them. Goods and ser­vices fall into 3 main cat­e­gories: needs, wants and invest­ments. Emo­tions often blur the lines between these categories.

Needs are min­i­mum require­ments to sus­tain life, such as cloth­ing, food, water, air and shelter.

Wants make life more plea­sur­able and may be related to needs. Wants may improve life, but one can sur­vive with­out a com­puter, auto­mo­bile, or cof­fee. They are not life sustaining.

Invest­ments are pur­chased with the expec­ta­tion of receiv­ing greater eco­nomic ben­e­fit later. Buy­ers (investors) think finan­cial gain out­weighs risk of poten­tial loss.

Bor­row­ing (financ­ing) sig­nif­i­cantly changes the dynamic of any pur­chase, irre­spec­tive of need, want or invest­ment. As his­tory has demon­strated time and time again, IB&Gs have lim­its to the amount each can bor­row. With this in mind, those wish­ing to bor­row should seri­ously con­sider a repay­ment strat­egy and plan before engag­ing in financ­ing. Unfor­tu­nately, too few peo­ple con­sider a long-term repay­ment process until it is too late.

Income and sav­ings may be per­ma­nent solu­tions to meet­ing needs. Financ­ing needs is a short-term solu­tion which may be war­ranted due to tem­po­rary cir­cum­stances, such as unem­ploy­ment, decreased earn­ings or unan­tic­i­pated expen­di­ture. When sat­is­fy­ing the need for shel­ter, home­buy­ers often finance a sig­nif­i­cant por­tion of their home pur­chases. Many home mort­gage pay­ments include both inter­est and prin­ci­pal. These home­buy­ers have a built-in debt reduc­tion plan, and could ben­e­fit from accel­er­ated prin­ci­pal pay­ments. Shel­ter is a need. A man­sion is a want.

Financ­ing con­sump­tion (wants) is dan­ger­ous because this type of spend­ing rarely pro­vides long-term ben­e­fit to the pur­chaser. Debt usu­ally long out­lasts the ben­e­fit of the financed good or ser­vice, and gen­er­ally is a bad idea for IB&Gs. Bet­ter to post­pone the pur­chase than pur­chase on credit. If you can­not afford a pur­chase with­out bor­row­ing, seri­ously con­sider whether you truly need it.

Financ­ing invest­ments also can be dan­ger­ous because bor­row­ing can mag­nify both invest­ment gains and losses. Con­sider the best and worst case sce­nar­ios (i.e., the risk-reward pro­file) for every invest­ment, espe­cially those involv­ing lever­age. Investors who use lever­age expect the gains from invest­ment will be greater than the cost of bor­row­ing. Invest­ments not expected to exceed the cost of bor­row­ing should not be under­taken with lever­age. Many peo­ple choose to bor­row to pay for higher edu­ca­tion. This can be con­sid­ered an invest­ment if addi­tional edu­ca­tion is expected to result in higher earn­ings, which could off­set bor­row­ing costs.

Financ­ing is an impor­tant instru­ment of mod­ern economies. Financ­ing also can be destruc­tive when inap­pro­pri­ately used. IB&Gs should seri­ously con­sider all aspects of financ­ing before bor­row­ing money. Wants are often dis­guised as needs and invest­ments and buy­ers should exer­cise cau­tion. Pon­der care­fully and objec­tively before engag­ing in any financ­ing situation.

About the Author

About the Author: James R. Peters is the author of The Prosperity Track: Energize, Enable, Empower and leads Integress Financial, where he oversees portfolio management, client financial advisory, and business strategy. With over ten years of experience managing investment portfolios and providing customized financial advice, he has personally assisted hundreds of people along their Prosperity Track. .


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