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Chiawono’s Three Rules (Part 2)

13 Oct
If you happen to arrive at this page without reading the first part, you can do it here
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Ok. So now that we have our Emergency Funds, what’s next? Can we go and talk about investments? Well, read carefully, and you will notice that what I am going to share is called “the Chiawono’s Three Rules before You Start Investing on Anything” and we have covered only the first rule so far. So here comes the second rule: zero bad debt.

Here’s the thing: there are good debts and and there are bad debts. Let’s talk about the differences some other time, but here we have several examples of bad debts:
1. If you don’t pay full payment for your credit card bill, that’s BAD debt. Especially if it’s been going on for some time.
2. If you owe the credit card issuer more than you earn, that’s BAD debt. In reality, since we have our regular spending, it’s considered bad enough if your debt is more than one third of what you earn.
3. If you borrow money from pawn shops or loan sharks, that’s BAD debt.
4. If you happen to have payday loan, that’s BAD debt.
5. You get the idea. Every debt that has ridiculously high interest rate or has no collateral whatsoever can be considered bad debt.

Editor’s Note: For Indonesian readers: ‘pawn shop’ is ‘pegadaian’, ‘loan shark’ is ‘renternir’, and ‘payday loan’ is ‘kasbon’.

So, if you happen to have bad debt(s), PAY IT OFF. NOW.  If you can’t, then work hard and pay it off as soon as possible. Here’s why:
1. Believe me, most of your bad debts will have MUCH higher interest rates (with a minimum of 2 to 3 times) than your normal investment return. So it’s IMPOSSIBLE to pay off the interest of your debts using the interest or yield of your investments.
2. Compounding interest is the world’s most powerful force (according to Albert Einstein). Most bad debts have these kinds of interest structure. So it’s better to have the force on our side (when we’re investing) rather than have the force against us (in our debts).
3. What if I put my money to a high yield investment? That’s a bigger NO-NO. While the yield probably will won’t be as high as the debt rates, you’re putting yourself in a bigger risk of losing your capital. And then, you’ll be in a deeper trouble.
4. But someone else is borrowing money from one place and invest in another place (or so you think you’ve heard)? Well, there are a lot of investors doing this stuff. It’s called carry trade. But they’re aware of the risks not to mention they are mostly much much much smarter than normal folks like me and you. So, don’t do it. Seriously.

Now, probably you’ve noticed that i use a lot of capital letters in this second part. Personally, I can’t help but try to emphasize that BAD debts are indeed BAD. Only when you’re free of bad debts that you can start to build a good financial plan. And on the other hand, there are lots of good debts as well: house mortgages, student loans, a car loan (if you need one), etc. Feel free to take them after calculating your financial health. Remember, just like our body, a healthy loan can become unhealthy if not taken care of.

See you in the third part.
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Posted by on October 13, 2011 in Chiawonomics

 

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