Mixing Maroons - Spend Less, Save More … Get Marooned!

Mr. Maroon

January 10, 2014

Equity as an Equalizer – Part 1

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(NERD ALERT! – My apologies in advance.  I went full nerd a couple of times in this article.  It happens from time to time.  Just bear with me.)

Cash is King

C A S H.  Funny how our whole existence in today’s modern world seems to revolve around that little four letter word.  Those who don’t have it, want it.  Those who do, want more.  We’re obsessed with it!  It drives many of us to drag ourselves out of bed each morning and trek somewhere we don’t want to be to do things we don’t want to do for people we don’t even care about.  We must be obsessed with cash to continue that existence!  Or at least we should be, if only temporarily, because cash can be your key to freedom!  Too many of us, rather than befriend cash and save it as if it were the hard earned prize it is, we throw it away on useless crap in an attempt to add value to our lives because, if you’re anything like I was, you think it will offset that feeling you have each morning when you embark on that objectionable trek.  So, how do we break the monotony?  Spend as little as possible, particularly on those items which lose value, and invest the rest wisely in interest bearing and/or appreciable assets.  Without adequate cash flow, though, it may be necessary to enter into debt – but, do so wisely!

Earning Debt vs. Non-earning Debt

You’ll often hear people say that there is such a thing as “good debt”.  I HATE debt!  I subscribe to the notion that no debt is a good debt.  Thus, I have a newly established rationale on debt.  I now categorize debt based on its ability to offset cost, either by generating income or increasing in value (which is sort of the same thing as generating income).  For example, if I buy a widget on credit for $1,000 at 10% simple interest, my structured outlay of cash for repayment is $1,100.  That widget can do two things:

  • It can decrease in value over time or cannot be used to generate income greater than $1,100 during its useable life.  If it does so, we call it a “non-earning debt”.
  • It can increase in value over time or can be used to generate income greater than $1,100 during its useable life.  If it does so, we call it an “earning debt”, which is still not acceptable to us anymore, but it’s better than the alternative.

To complicate matters, our financial lives are often a collection of widgets each purchased on credit for different prices and interest rates, resulting in a matrix of both earning and non-earning debt.  Remembering that debt is debt, we have made it our personal goal is to rid ourselves of it.  For us, the best approach for dealing with debt was to erase non-earning debt first – and as quickly as possible.  We accomplished this is by selecting the smallest debt (car loans) and throwing all of our extra income to it.  When we finished with those, we combined efforts and tackled the next one (student loans).

(Note:  There are a contingency of financial minded advisors out there that recommend analyzing your debts based on a time-value of money approach which maintains that debts with interest rates below that which could be earned by an investment should be paid off as structured instead of paying them before their maturity so that would-be additional payments can be invested to earn a larger interest rate.  The interest rate generally thrown around is 7%.  I understand the math, but I hate debt – so my goal is to strive to be debt free!)

Debt Tip:  Growing up, I inaccurately learned that debt was acceptable because it allowed you to have what you want.  Or, at least it allowed you to have what you want right then.  When you decide later that you want something else, debt becomes a huge burden and, unless you go deeper in debt, inhibits you from having what you want.  Nowadays, I HATE debt!  As I’ve said before, wealth means nothing if you owe it to someone else.  So, debt must be had, I find it only acceptable to have on appreciable assets, or what I call “earning debt”.  While we utilize credit for other means, we no longer EVER carry debt on a financial liability, aka “non-earning debt”!

As we pay off our debt we earn equity.  Equity represents our ownership of an object based on the ratio of our debt to its value, regardless of its value.  Mathematically, as a percentage:

Equity = (1 – ( debt / value )) * 100

There are four possible scenarios:

  • 100% Equity.  The object belongs to us free and clear.
  • Positive Equity.  The object is worth more than we owe.
  • Zero Equity – The object is worth exactly what we owe.
  • Negative Equity – The object is worth less than we owe.  This is commonly known as being “upside down” or “under water”.

Obviously, our goal is to have 100% equity in all of the items we own because:  1) equity plays an important role in our net worth calculation and 2) it means we’re debt free.  But, let’s not equate equity, and therefore our net worth, with cash just yet, particularly if our equity is in a non-liquid asset.  Net worth represents our financial value, but it doesn’t necessarily represent our financial power.  In order to benefit our wealth accumulation strategy, equity must work for us.

Equity as an Investment

Back when I had a horrible habit of materialism, I maintained that many of the items I was buying would retain, or even increase, in value – a concept that Mrs. Maroon constantly reminded me only mattered if my intentions were to sell those items at some point in the future.  I was naively content to have the equity and increasing value, but neglected to consider that the equity and value, while it increased our net worth, actually damaged our retirement potential because I had no plans whatsoever of selling those items.  As part of our new lifestyle, we now approach spending with a revised frugality – essentially asking ourselves these two questions with every purchase:

  1. Do we need, and I mean really NEED, it?  If not, skip question 2, put it down, and leave the store.
  2. Will it help us generate income?  In other words, can we use it to make money, either by selling it for a higher price than we paid or by making it work for us?

We also are trying to incorporate this decision structure into the items we already have.  Like we’ve said from day one, our house is full of crap.  As we go along, we must continue to separate the chaff and rid ourselves of the unnecessary clutter.  What to do with those items that make the cut?  Let’s put ‘em to work!

~ Mr. Maroon

Equity as an Equalizer – Part 2
FF #1 - Save those Berries!!

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