As I think about it, our national debt increases every year because of a multitude of factors including our almost universal propensity to not think in terms of the long run. We are blind-sided by being short-sighted. And it comes at a great cost.
Humans tend to think short term for most things. What are we going to eat tonight, what are we going to wear tomorrow, what is the weather like this weekend. While it is important to live in the present, we should balance that with adequate planning for the future. Most, if not all of our daily decisions are for the short term but as a result we often neglect our long term goals.
Interest – The Real Long-Term Cost
In terms of interest, many of us are unaware of the real cost over time. Interest adds significant cost over the life of a loan and should not be ignored. Banks and other financial institutions know this and so should you.
When we buy a house, we often think about the asking price, the closing costs, and our down payment. These are all very important in terms of purchasing a home, but we often dismiss that small negligible number attached to our mortgage… the interest rate! Interest rates are funny. They sound so small and negligible.
Current interest rates for mortgages start around 4% for a 30-year fixed rate mortgage. Sounds so small and insignificant… right? Wrong!
Take a look at this example using a free online mortgage calculator:
Factoring in average Real Estate Taxes and cost of homeowner’s insurance the total cost of mortgage over the life of the loan is:
almost twice as much!
We need to think about the long-term consequences of our decision to purchase a home.
While real estate mortgages are costly, historically the value of real estate increases over time making it a worthwhile investment long-term. The same can not be said for car loans. Cars tend to depreciate in value over time with the exception of antique and otherwise rare cars.
Let’s look at the terms of a typical new car loan:
Loan term: 5 years or 60 months
Interest Rate: 4%
Total cost of car loan: $33,150
Not too bad, right? Wrong!
The average value of that new car after 5 years is only
If you take the total cost of the car after 5 years $33,150 and subtract the value of the car after 5 years you get a difference of
That car cost you a pretty penny. Factor these into the equation when making decisions for the long-term.
We all know by now that credit card debt can be harmful. Credit cards can be a useful tool for protecting from fraud, earning rewards, etc but it comes with a significant cost long-term .
The current average credit card interest rate is 17.65%
Let’s demonstrate with an example scenario:
$5,000 credit card debt
Payoff term of 60 months (5 years)
Interest rate (average) 17.65%
Your monthly payment would be $126
Total interest paid: $2,561
Your total cost of the $5,000 credit card debt would be:
34% of the total cost goes to interest. Yikes!
Rainy Day Fund
We should set aside between $500-$1,000 for that inevitable bad day when something suddenly goes wrong. This protects us from that sudden expense or disruption in income that can happen without warning.
This money is set aside as cash is able to be withdrawn quickly as needed for that car repair, leaking roof, or broken appliance.
Unlike a rainy day fund, an emergency fund offers protection from a more serious disruption in income or larger emergency expense. Ideally, an emergency fund should be equal to 3-6 months of income.
What happens if you have an illness, injury, natural disaster?
Let’s say that you bring in $4,000 a month in income. Take $4,000 and multiply by 3 and you get $12,000. Even better double it for additional protection.
Don’t have adequate funds yet? Seems impossible? Don’t worry. Break it down into achievable steps. Save money by cutting expenses as able and setting aside the difference. Better yet, put the money in a higher interest online only savings account for additional savings. But do it. It’s practically certain that an emergency will happen.
The Stock Market – Short-Term vs Long-Term Investing
There are 2 main types of stock market investing, short-term and long-term investing. This includes investing in ETF’s and mutual fund investments which are that are multiple stocks bundled together.
The stock market is a great way to take advantage of interest. Compound interest, interest earning more interest over time is a great long term strategy to build wealth.
Keep in mind, there are multiple strategies with both short-term investments and long-term investments.
In terms of thinking ahead, investing in the stock market is just that, putting money behind companies that we think will make money in the future. That ultimately is what people do when they purchase or sell stocks. They are essentially betting money behind a prediction that stock prices will go up or down. To be a stock market investor, you are thinking ahead instead of just the here and now.
As I research the stock market every week, I am amazed at the level of confidence people tend to have in themselves to predict the future stock price by the end of the day, week, or month. They use graphs, formulas, and ratios to justify their predictions. While some strategies can work, you should combine technical analysis with a healthy dose of skepticism.
On stock websites, you have bulls and bears arguing about which way the price will go. At best, it’s an educated guess.
Short-Term Investors are focused on the price fluctuations that occur within months, weeks, or even within the day. This strategy tends to be riskier because the shorter the time horizon for expected returns, the less chance of recovery.
Short Term Investors have to contend with capital gains tax as well, that can take a large chunk out of profits.
Short-Term Capital Gains Tax are taxed at the same rate as your ordinary income. This is only for investments that sold in less than a year.
Long-term investors focus on the value of a company on a time horizon exceeding a year. There are many benefits in terms of stock market strategies for thinking long-term. The risk is leveraged by the willingness of long term investors to set aside their money for longer periods of time, giving a longer opportunity for stocks to recover and go up. Also the capital gains tax is significantly lower than that paid by a short-term investor.
Long-Term Capital Gains Tax rates are lower at 0%, 15%, or 20% are for Overall the long-term stock market returns tend to increase on average about 10 percent per year. Not a bad return on investment.
Align Your Mind
- Consider the long-term costs of assuming debt with interest.
- Think of long-term saving strategies to protect yourself from misfortune.
- Use long-term wealth building strategies with investments to take advantage of interest.
It’s not rocket science but it takes discipline to overcome our human nature to think about the here and now. Set goals for yourself and accomplish your dreams for the long run.