The first step to becoming a successful household CEO is to understand the tragic consequences of fiscal irresponsibility. A household CEO that fails to understand this is equivalent to an automobile driver trying to navigate rush hour traffic with a blindfold over his eyes.
I’m a big trivia nut, so let’s start this lesson off with some interesting, but disheartening, facts.
Fact 1: The personal savings rate for the United States continues to languish at its lowest rate in history and has been poor for many years. In fact, savings habits have been declining since 1985, when we saved 11.1 percent of our income. Up until the recent global financial downturn, the personal savings rate in the United States was virtually non-existent. In 2006, the personal savings rate was a negative 1%. That’s right, I said negative. The negative term doesn’t mean that people weren’t saving money in 2006. It means that they were spending more than they were making; simply put, outgo was greater than income. For example, this condition can arise when a household can put $1000 away during the year in a savings account, but take out loans of greater than $1,000 over that same time frame.
Fact 2: A Federal Reserve Board Survey of Consumer Finances conducted in 2004 found that although the majority of households carried no credit card debt, of those that did, the median balance was $2,200.
Fact 3: The same Federal Reserve survey found that one in 12 households carry credit card balances of at least $9,000.
Each of these examples are symptomatic of households that fail to manage their household finances as a conscientious household CEO would. Instead, they run their households more like those reckless corporate CEOs we read about, racking up tremendous amounts of debt without a care in the world, in the face of insufficient earnings.
That’s not to say that all debt is bad. It is not. In fact, there is good debt and there is bad debt, which I will talk about in a later post. But it is imperative that a good household CEO realizes what many of today’s corporate CEOs do not: that is, there are limits to the amount of debt that even the wealthiest corporation (or household) can carry. To ignore that truth is just plain fiscally irresponsible.
So why should you care how much debt you take on as long as you am able to make all your payments?
The answer is simple: Taking on excessive debt limits your ability to make decisions in the future. That is because when you take on new debt, you are spending tomorrow’s wages today. Maxing-out your credit cards, tapping your home equity, and borrowing against your retirement funds greatly reduces the wealth you can accumulate in the future.
On the other hand, paying off debt removes the liability and frees up money that previously was being spent on interest payments. When we are not getting ourselves deeper into debt, we are better able to put money away for that proverbial rainy day.
So just as getting into debt limits future choices, saving your money buys yourself control. Keeping a comfortable margin of financial resources from being obligated to pay past debts gives you the luxury of allowing you to handle the multitude of financial emergencies that will undoubtedly arise over the course of a lifetime. And when it comes to saving money, a little bit here and there can add up quickly.
It is the household CEO’s duty to steer clear of fiscal irresponsibility at all costs. Being fiscally irresponsible ultimately reduces the wealth you can accumulate in the future. It can also lead to something as benign as personal embarrassment or as catastrophic personal bankruptcy.
In my next post I will focus on the second principle that every household CEO must understand before he or she can do the job properly: knowing the difference between a want and a need.