Why you should put something away for a rainy day

Why you should put something away for a rainy dayWhen you have money, think of the time when you had none. ~Japanese Proverb

Dear Reader, have you ever considered why you should put something away for a rainy day?

When you’re doing well and you have a good income, it’s easy to imagine that the good times will go on forever and you can just enjoy it all with the expectation that money will continue to flow in your direction without interruption.

But life’s not like that. Into every life, some rain will fall, as the saying goes.

Good times don’t last forever. Life tends to be cyclical, like the changing of the seasons.

The time to repair your roof is when the sun is shining, for winter will have its day and we must be prepared for inclement weather.

Savings matter:

When you get paid each month it is essential you set some money aside, separated into three accounts, as follows:

    1. Bill Payment Account
    2. Emergency Account, and
    3. Financial Freedom Account

You must be prepared for paying those bills that come in regularly; you must be prepared for an emergency, and you must start creating wealth so that one day you’ll be able to retire.

Bill Payment:

You cannot live in the modern age with incurring bills.

Whether it’s utility bills, phone bills, TV subscriptions, mortgage payments or rent, credit card payments, food bills, repayments on a car loan, et cetera. You must set money aside to pay all those bills when they fall due.

Emergency Account:

As the saying goes, stuff happens.

And when stuff happens you must be prepared to deal with it. You must have an emergency fund you can tap into to deal with emergency repairs or even an unexpected interruption to your income. These things do happen.

Financial Freedom:

When you’re young, it’s easy to think that you’ll just keep on working, if you must, to earn an income.

However, trust me, one day you will want to retire from work, or at least from the daily grind.

If you are to retire you will need some wealth.

The best time to start building wealth is when you’re young.

Start a 401K or pension whilst you’re young, pay into it regularly and with some luck and good financial management, you can enjoy a comfortable old age.

By starting young you will benefit from the magic of compounding. The impact of compound interest should not be underestimated.

Remember; it will rain:

Think of life in terms of the seasons and prepare accordingly.

Most people experience hard times at some point in their lives, particularly when they’re young.

You can be sure it will rain; the only question is when.

You will be able to weather the storm a lot better if you have a financial cushion in the form of some savings.

If you are lucky enough to have an income now, you’d do well to remember to put some of your income away for a rainy day.

It’s easy to squander your money thinking the good times will never end.

However, nothing lasts forever. So, be prepared.

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Types of debt and why they matter

Types of DebtIf you’re starting out with your financial education then a good starting point would be to understand the different types of debt and why they matter.

Personally, I categorize debt as either good debt or bad debt.

Understanding the difference between the two is essential if you don’t want to remain poor all your life.

Do you carry some debt dear reader? If you do, you’re not alone.

Now you may think that debt is just part of life, and you may even believe that debt can’t be avoided.

Debt is certainly very hard to avoid, that much is true.

However, don’t forget that personal debt is a burden on us because it has to be serviced and eventually repaid.

Yes, it may be a burden you can’t avoid but it’s no less stressful potentially for that technicality.

For emphasis let me repeat, in my opinion, there’s good debt and then there’s bad debt.

The obvious question is when is a debt considered bad debt? To put it another way, when is debt a bad idea?

Let’s consider some examples of debt.

1. Secured Debt:

Buying a house is an example of secured debt.

When buying a house, most people need a mortgage, which is of course debt.

However, as long as you don’t overstretch yourself, mortgage debt is usually manageable for most people. And it’s rare that a lender will allow you to overstretch yourself these days.

With a mortgage, the debt is secured against your property, so the risk for the lender is small.

If you fail to repay the mortgage loan, a lender simply repossesses the property and sells it to recover their money.

So because the associated risk to the lender is low, interest rates on secured debt are low too.

Coupled with long repayment periods, typically around 25 years, the monthly repayments on a mortgage are not significantly different from what you might pay if you rent a property.

So, borrowing to purchase a property, I would say is good debt because eventually you’ll repay the debt and own the property, assuming you repay in full.

It’s good debt because it results in the long-term acquisition of a valuable asset.

You need a roof over your head, of course, so buying with a mortgage makes good financial sense because at least you’ll own the property in the future.

And with luck, you’ll enjoy some capital appreciation on the value of the property too. That’s not guaranteed of course but historically that’s been the trend for those holding property assets for an extended period of time, certainly in the United Kingdom.

In summary, secured debt bears the lowest interest rates and leads to the acquisition of a valuable asset. So in my opinion that makes it good debt.

2. Unsecured debt:

When is debt a bad idea? The simple answer is when it’s an unsecured debt.

And what’s unsecured debt?

It’s a debt against which nothing valuable has been put up as security.

If the borrower fails to repay, the lender has nothing it can repossess to sell on to recover the balance outstanding. So for the lender that represents increased risk.

And because unsecured debt has no form of security then to compensate, the interest rate charged by the lender will be high, and sometimes very high.

The interest rate charged reflects the risk to the lender. The higher the risk the higher the interest rate applied.

Lenders recognize that there’s a risk that a proportion of their clients will fail to repay unsecured loans, so those who do make the repayment in full, have also paid a premium in order to protect the lender from any losses they might have incurred due to non-payment by others.

Now of course there will be occasions when unsecured debt is unavoidable.

For instance, young people just starting out might need some basic items of furniture for their homes. A bed would be a good example. You must have one and if you can’t afford it, then you might need to use a hire purchase arrangement. Handled with care then this shouldn’t be a huge problem.

3. When is debt a bad idea?

So when is unsecured debt a really bad idea?

Put simply, when you start buying with unsecured credit that which you could live without. That gadget you couldn’t resist or those shoes that looked really nice in the store. Non-essentials you could have lived without until you had saved the money to pay for them.

You know the experience, I’m sure. You see something you can’t resist, out pops your flexible friend, and an impulse purchase is made before you’ve thought about whether it was a good idea or not.

The reckless use of credit cards, store cards, and payday loans can be a disaster because this type of debt is not secured against anything, so naturally, the associated interest rates applied are very high.

Credit card or store card debt can bear interest rates of around 30% or more.

In the UK, payday lenders have been known to charge interest rates equivalent to 3000%, 4000%, or even 5000%.

I find it hard to believe people fall for these loans but they do. I guess if people are desperate sometimes then perhaps they feel they have little choice.

4. The magic of compounding:

Why does this matter? The simple answer is the magic of compound interest.

The compounding effect of high rates of interest will quickly turn small sums borrowed into enormous sums owed.

For instance, if you borrow $1,000 at 3% interest, after five years you’ll owe $1,159, assuming nothing was repaid.

However, if you borrow $1,000 at 35% interest then after five years you’ll owe $4,484, again that’s assuming nothing was repaid.

The difference is a massive $3,325. And more importantly, the value of your debt has also quadrupled.

So when interest rates are high, even if you make minimum payments, your debt can grow rapidly if you’re not careful.

And that’s when you can become enslaved by your debts.

And that’s why it matters. Ultimately this burden can become very stressful.

5. Manage your money:

Types of DebtFar too many people borrow money in the form of unsecured debt to purchase discretionary items. That’s items they could live without if push came to shove.

Wasting money in this way is a really bad move. Not just bad it’s seriously stupid.

I recommend that you follow this simple rule: If you can live without it, never use debt to buy it.

Yes of course it’s nice to have the latest smartphone or the latest television or whatever but is it really worth the pressure of unnecessary debt?

When high rates of interest start pushing up the sum outstanding significantly, you have to ask yourself, will the burden of this unnecessary debt still seem worth it? I doubt it.

Wouldn’t it be better to wait until you’ve saved up the money to make the purchase instead?

Wouldn’t it also be cheaper in the long term to save up and buy the product when you actually have the money? You’ll appreciate the item so much more too.

The message is simple: Manage your money or your money will manage you:

6. Debt is a form of slavery:

Being indebted is just a form of slavery. It’s as simple as that really. And, once again, that’s why it matters.

For as long as you owe money you can never be truly free.

If you’re debt-free then you’re stress-free too. Wouldn’t you prefer to be debt-free and stress-free?

Good debt will help you but the bad debt will make your life a misery.

7. Conclusion:

Put simply, there are two types of debt, good and bad.

Debt is either secured or unsecured.

Interest rates on the former will be relatively low, whereas interest rates on the latter can be very high.

Interest rates matter because of the compounding effect.

Unsecured debt can be the road to the poor house, particularly if you use it to buy the stuff you could live without with credit that bears interest rates that are very high.

The type of debt that’s bad will enslave you and it’ll become increasingly stressful.

If you only take one message away from this article then that’s it.

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So please share this post now. If you do, I’ll be ever so grateful. You’ll be helping a keen blogger reach a wider audience and that’ll be your good deed for the day.

Thank you.

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