Financing Consumption: A Dangerous Proposition

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.