Liability Management

If you ask 100 people what financial planning means, 99 of them will answer you with talk about the conservation and growth of their assets.  

Let me tell you my definition of financial planning:

1. Either you’re going to die young, or you’re not.

2. If you are still young, get enough insurance to protect your family in case you die young.

3. If you’re not going to die young, retire with sufficient net worth so you can support yourself comfortably until you die.

Growing your net worth isn’t just growing assets.   Most people have significant liabilities too and disciplined management of liabilities can have just as significant effect on net worth as shrewd management of assets.

Many people think of debt management only as eliminating credit card debt.   That certainly is a good step.   There are exceptions to every rule, but a good rule is that you should not put anything on a credit card unless you are able to pay it off in full when the statement comes at the end of the month.

If you have accumulated debt, the worst plan is to make the minimum payment every month.   That keeps you in hock forever!   Sit down and make a plan to eliminate debt as soon as you can. First, see if you can transfer some or all of the balance to one of those “zero percent interest for six months” credit cards. Next, add up your debt, and use one of the many calculators on the Internet to calculate whatever payment is required to pay off your debts off in, say, 30 months.   Then start paying off the cards, starting with the ones that have the highest interest rate.

Second, it makes a lot of sense to keep cars for a longer period rather than shorter period. After the car is   paid for,   start saving what used to be your monthly payment. It is just as easy to put $400 per month into a savings account as it is to send it to a lender. You goal is to save enough to pay cash for your cars rather than finance them.   When you do the calculations, the result of buying fewer cars and investing that same amount of money every month is staggering, on the order of hundreds of thousands of dollars over a lifetime.

Finally, it is important to be wise in managing your mortgage. Most people just “get a mortgage” the same way they “get a barbecue.” They perceive it as a thing instead of a financial instrument.   The fact is that at various times in your life and at various times in the business cycle when one type of mortgage is better than other. Making the proper choice will save you thousands of dollars, and you can always trade your loan in when you get to a different part of the cycle.

Once you have a mortgage, there are also a number of choices to be made about how much to send in every month. Most people jut send in the obligatory payment that is listed on the coupon.   Sending in the minimum payment every month is a terrible credit card management policy. It’s just as bad a policy with the mortgage because the mortgage is bigger. Sending in the minimum payment keeps you paying interest for the longest period of time.  

A better strategy is to figure out when you want to have your loan paid off, say when you’re 65.   Using one of the Internet calculators, figure out what kind of a payment is necessary to pay it off in that number of years and start sending that payment in.   The total interest savings can be staggering.

If   you are refinancing at today’s low rates, your objective should be shortening the term of your mortgage, not getting a lower payment.   Refinancing into a succession of 30-year loans means that you never will get your house paid off.   If you are 5 years into a 30-year loan and lower the rate but keep making the same payment, you may find that your new loan will actually be paid off in 20 years. Your savings?   60 times your monthly payment!

If you are over 40 years old, you should seriously consider getting a 15-year mortgage.   The payment may not be much higher than your current payment, and all of the added payment is going toward principal reduction.

In short, there are a lot of questions that you should be asking yourself on a regular basis about liability management.   Set goals and then take actions that result in meeting those goals.