Wednesday, April 29, 2015

Good Debt, Bad Debt

If it is hard to understand what money is, debt takes it to another level. At some point as financial instruments get progressively advanced, they step almost into the religious or philosophical zone. There is a jargon barrier that prevents you from even understanding what someone is on about. Sometimes it is actually not worth learning that language because the experts aren't right. Problems can be solved and so smart minds go on to work on something else. Those smart minds may then not even be in a position to engage with, or deconstruct complicated arguments that 'back up' incorrect theories. This is the problem when real progress is on the edges. Fake progress lies there too. So who are we supposed to trust?

I suspect many of the key mistakes we make aren't the ones on the edges. They are in the middle, but we define ourselves so narrowly we don't know that. We don't take the time to actually find out enough about the little things in life that would make us a little more competent. I am not talking about rocket science here. I mean things like domestication (making beds, ironing, handiwork, shopping, cooking). I mean managing household finances. I mean nutrition. Exercise. Everyone should know a little anatomy, for example, since we are in our bodies for a rather long time. But we specialise in the things we are good at. This excludes us, not only from the things on the edges, but things that are within our grasp but we don't know it.

Most of our mistakes don't lie at The Edge.

Without getting complicated, I think there are two basic types of Debt. Good debt is a smoothing device. If you know there is going to be an irregular flow of money coming in, you can borrow a bit in the short term when you need to and pay it back when you have too much. You can also do this by building a buffer. So instead of spending your last cent mid month and going into the red, you can be extra tight until you have three or so months of salary in the bank. This buffer means you don't go into overdraft unless you really need to. That initial extra tightness takes a load of stress going off.

Good Debt shifts things around - across time and between people. Bad Debt is the kind that 'creates money' out of thin air in order to spend. When you want something, and don't have the money coming in. Borrowing is just a very expensive way of buying something. If that something is something you consume, then you may be 'paying for nothing' for a long time afterwards.

Good debt would be the kind that takes money that would otherwise be idle, and puts it to work. Banks don't actually hold big vaults of money. If your or a businesses money is 'in the bank', it is likely working for someone else. A Bank can be thought of as an employment agency. I think of money as an employee. If you put it in the Bank as cash, the bank will lend that money to someone else to use. They will find it a job. In that way they 'create money' since you still have your employee on paper. But in a good way. You think it is sleeping, but it is actually working for someone else. A good bank will make sure that money is doing something productive.

Even if you don't like thinking about money, knowing the difference between good debt and bad debt is one of those things worth putting a little time into. Money doesn't buy happiness, but it can certainly destroy it.
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