Study Up On: Living Within Your Means

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Living within your means can denote a lot of different things to various people. It depends not only on who you ask but how you ask!

  • Some folks may see that their total monthly cash outflow is less than their cash inflow and feel okay with that.
  • Some savvier individuals know they need to limit cash outflow and maximize savings if they ever want to reduce financial stress, achieve financial independence and retire in what is categorized as a ‘short career’.
  • Some people apparently have no idea what it means!

I can’t fathom when I read that average Canadian household debt is 170% of disposable income. It makes me cringe. What happened? Do people not understand “Living within your means”, have a twisted comprehension of it, or simply ignore it and live the high life for as long as they can?

To me, 170% Debt-to-Income is a reflection on culture.

  • Today, it is culturally acceptable to spend more than you earn;
  • Today, it is culturally acceptable to save nothing and rely on social programs to bail you out (even though said social programs are meant to supplement retirement income / support low income households who are not as fortunate as others).

How did this culture come to be? Here are my thoughts:

Prolonged Government Intervention in the Economy

Governments play a pivotal role in our greatly advanced society, true. I believe when operating correctly, government can balance the scales between various income levels, provide for those who cannot provide for themselves, and play a role in keeping the economy stable when required via monetary & fiscal policy.

It is well known that government can use monetary policy, such as lowering interest rates, to spur economic growth. By lowering interest rates, corporations have access to relatively cheap money, which they will take as long as they are fairly certain they can invest said money in a project yielding a better return than the interest they are paying on the loan.

Corporations are not the only ones who reap the reward of cheap money as banks and secondary lenders typically pass some of this along to individuals by reducing loan interest rates, like on a mortgage product. This incentivizes the individual to spend more and boost demand across the economy. Monetary & fiscal policy tries to fight a trough (down period) in the economic cycle.

However, when interest rates are held down artificially for a DECADE (since the 08-09 financial crisis), there are a number of repercussions. I can see it manifesting itself culturally as people my age have only known suppressed borrowing rates throughout their young adult lives. They simply do not know that they are borrowing money on the cheap relative to historical norms.

So what happens?

These young folks tend to tack on more and more and more…and more debt than they should. Why? Because it’s cheap! They are paying practically no interest to borrow money they do not have, to pay for things they cannot afford.

When you do this, you are taking on interest rate risk. When rates start to rise, you pay more interest on outstanding loan balances. If you are leveraged to the hilt, you cannot afford a rate increase because you already have zero money left over already. You are spending every last nickel to cover existing carrying costs.

This causes people who are stretched to default on debt when rates go up. And now Canadian government is in a tough spot because while rates were near zero for so long (once again, a DECADE), Canadians piled on the debt. They now carry so much interest rate risk, the government cannot afford to raise rates to where they should be, fearing high default rates on mortgages, housing crashes and triggering an economic down cycle due to a credit crunch.

Too much government intervention leads to a “credit coddled culture” for young adults which is bad news for long-term economic growth and innovation!

Lack of Personal Finance Education

I wrote about this one earlier. More on this here. Again, as there is a lack of personal finance education going on, younger generations only know cheap money.

Why wouldn’t I use credit cards and loans to get things I want NOW when the cost is so small?!

For many Millennials, I have noticed there is no delineation between the following two scenarios:

  1. Buying an asset with cash*;
  2. Buying an asset with some cash and the remainder on credit and actually only owning a fraction of the asset. Oh, and owing interest…yikes**;

Ultra Consumerism

So much to be said here about North America’s ultra pro-consumer mindset. The impact social media has on younger generations these days is especially astonishing. I think social media can have profound impacts on mankind culturally, but may swing in negative or positive directions. At the moment, I think it is primarily the former.

Social media is primarily used for following celebrities and lifestyle gurus. This can:

  1. Create a false sense of what can make an individual happy and fulfilled;
  2. Create a false sense that money is no object. “Just buy everything on credit and let future You worry about it! I’m YOLOing! Look how good I look in these pictures with all these items I don’t fully own!

Well that is it for my rant on debt-to-income. Let me know what “Living within your means”  describes to you in the Comments section, or any additional thoughts on why people may burden themselves with more debt than they should!

Stay frugal my friends!

*I say ‘cash’ here but really it is just buying an asset with an asset you currently own. Typically it is cash.

**I am generalizing. Of course people will take on mortgages and leverage themselves for a home. But what is worrisome is the size of the mortgage relative to their assets and income that is concerning.

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