Tuesday, September 8, 2009

Beware Of Debts And Excess Leverage

Beware Of Debts And Excess Leverage
Six months of stock market rally... holly shit! The bears (including me) have highlighted an impending drastic stock market correction for weeks but the stock market continues to defy gravity.

I know people are more confident when they see their investments doing well, regardless of the well-being of the real economy. However, such over-confidence can lead one to take on more debts than is prudent to finance purchases or investment.

To be sure, consumers and investors are not soley at fault. Banks, credit card companies and brokerages are eager to feed this frenzy by expanding our overdrafts, credit limit and margin accounts.

But excessive leverage is dangerous and will destroy our financial future. To get our finances to grow in a healthy manner, you must eliminate the weeds (debts and its associated interests cum fees) in our financial garden.

I believe many people realize the dire effects of debts, yet they willing become enslaved to financial institutions which offer credit cards and credit lines with low teaser rates and entice us to pursue extravagant lifestyles, way beyond our means.

Sometimes, I get really upset that our entitlement mentality, thanks to the media, politicians and unscrupulous lenders, has become so deeply entrenched that we believe we can always get what we desire right away, without paying for it.

Now isn't that naive? The banks and credit card companies are in business to make money, not to do charity work. Thus, all their easy money come with a heavy price to pay... eventually. There is no free lunch, period.

If we don't pay up, the only way is to kick the can down the road and burden the next generation with our reckless spending. The financial institutions are more than happy to let our debts snowball and to see us slog like hell to contribute to their profits in perpetuity.

To avoid the vicious debt ruthole, you must be disciplined in paying off debts as soon as possible. But you should not do it too aggressively such that your emergency fund is neglected. An emergency fund is crucial even as you keep track of current liabilities, so that your ability to make good on payments is not impaired even if you lose your job.

You should also get free credit reports and see whether there are any inaccuracies reported. If so, dispute the problem in writing and get it resolved. A drop in your credit score of just 50 points will cause your monthly payments to spike and even restrict your credit limit.

Next, examine your credit card and loan statements to see what interest rates you're paying. Do some comparison shopping for more attractive interest rates and then make a few phone calls to negotiate your existing rates.

If the phone calls are not fruitful, you can move your outstanding balances from higher interest cards to a lower interest card. Or pay off high interest credit cards with a lower interest loan.

These actions can save you hundreds or thousands of dollars per year, and only take a few minutes of your time to initiate. But you still get nowhere near eliminating your debts if you don't change your mindset and lifestyle.

Stop piling on more debts if you are serious about eliminating debts. You only dig a bigger hole whenever you charge new expenses to a card and accumulate your outstanding balances which cost you the most money in fees and interest.

I believe the the economy will still be in deflation for the short term, even though the Federal Reserve has been printing money furiously. And there is still a strong possibility that the economy will suffer a double dip and the credit crunch worsen in 2010.

But whatever happens, we can always cope with interest rate hikes or withdrawal of credit lines if we pare down our debts and get our emergency fund up and running.