The neighbors have a shiny new sport utility vehicle to tow their travel trailer. They take a two week tropical vacation every winter. Their family room is equipped with the latest large screen TV and surround sound stereo system. Many people believe this is a sign of wealth. In fact, this is usually a sign of consumption.
More often than not, the above lifestyle is funded with huge amounts of debt.
Fewer and fewer car ads list actual vehicle prices. Instead, they advertise supposedly low monthly payments. Often these payments are for a lease based on a minimal annual usage. If the vehicle is driven more, then the monthly lease payment will be higher.
Lenders have made it easier for borrowers to access the equity in their homes to fund lifestyle expenses. Many merchants offer financing on larger purchases, and some may even defer payments for many months, even years. Make no mistake; these purchases will eventually have to be paid for.
Many consumers today forget that they have to make their purchases with after-tax dollars. For example, a $700, taxes-included monthly vehicle lease payment will require $1,076.92 of earned income for someone in a 35% tax bracket. This four-year lease will gobble up $51,692.12 of employment earnings.
Using a credit card to finance a consumer purchase can be extremely expensive. For example, a $5,000 purchase financed for three years at a typical credit card interest rate of 18.8% would total $6,579.72 in payments. Using the same 35% tax bracket, it would take $10,122.65 of employment income to pay for the $5,000 item.
Consider that the more things you have, the more time and money it will cost to manage them. We have all seen the self storage facilities dotting our landscape. RV storage yards take up dozens of acres around our communities. Don't forget to factor in the monthly storage fees, paid for with after-tax dollars, to the cost of ownership. A $200 a month storage fee may cost more than $300 a month in earnings.
Do without the nicer things in life? Of course not. We can, however, take a lesson from the rich on how to actually pay for some of our lifestyle expenses. There are two types of debt; good debt and bad debt. Good debt supports an asset and bad debt supports a gratification. The rich further define an asset as something that generates an income. Banks may define your house, a vehicle or recreational vehicle as an asset because that's where they make their income if you have financed it.
Another strategy the rich use is save from employment income, invest from savings and delay gratification purchases until the investment income is sufficient to cover their costs.
Tom and Claudette decided to use this approach for their lifestyle expenses. They borrowed $25,000*, deposited it in an investment fund and paid the loan back over three years.
After the loan is paid in full, assuming a 7% withdrawal rate, they now have $1750 of gross annual investment income. If the full $1750 was taxed as a capital gain and assuming a 35% tax bracket again, they would have $1443.75 to spend as they wish. If they used employment income, they would only have $1137.50 after taxes.
Tom and Claudette also make monthly deposits to their investment fund account to increase their future lifestyle income.
Copyright © 2012 Life Letter. All rights reserved. For informational purposes only and is based on the perspectives and opinions of the owners and writers only. The information provided is not intended to provide specific financial advice.. Readers are advised to seek professional advice before making any financial decision based on any of the ideas presented in this article. This copyright information presented online is not to be copied, or clipped or republished for any reason. The publisher does not guarantee the accuracy and will not be held liable in any way for any error, or omission, or any financial decision. * An investor proposing to borrow for the purchase of securities should be aware that a purchase with borrowed monies involves greater risk than a purchase using cash resources only. The extent of that risk is a determination to be made by each purchaser and will vary depending on the circumstances of the purchaser and the securities purchased. Discuss the risks associated with leveraged purchases with a financial planner before investing. Purchases are subject to suitability requirements. Using borrowed money to finance the purchase of securities involves greater risk than a purchase using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same if the value of the securities purchased declines.