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The Firemand and the Waitress book cover
The Firemand and the Waitress book cover

Book excerpt

Don't pay interest on money you don't owe Add to ...

Excerpted with permission from The Fireman and The Waitress by Dessa Kaspardlov, CEO of KL&A and creator of Dessanomics™



ENDING THE BALANCE SHEET TWO-STEP

One thing I know from years of studying human nature is that we don’t always act rationally, and the Dessanomics process was designed with human nature in mind. The Youngs are smart, responsible people who were paying about $2,300 a year for the illusion of saving while carrying the same amount in high interest debt. Not logical, right? But very, very common.

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The Youngs had some cash: $20,000 in a GIC and $2,500 in their savings account, for a total of $22,500.

They were confused when I asked them, “Why in the world would you pay interest on money you don’t owe?”

Okay. I’ve lost you now, too, I know. But let’s think this through together.

The Youngs had $22,500 on deposit at the bank. On both their GIC and savings account, they were receiving a very low rate of interest, less than 3%. They owed the bank a total of $22,500, $18,000 on a line of credit (at about 7.5% interest) and $4,500 in credit card debt at about 18% interest.

In other words, the Youngs owed the bank nothing but were paying almost 10% in interest every year (over $2,100!) for the privilege.

This is the situation that tens of thousands of Canadians are in today.

On top of the interest they were needlessly paying, they were also losing the opportunity to build wealth with the money they were using to pay off debt. That added up to payments of $600 each month when I met them ($350 on the line of credit and $250 on the credit cards.)

To add insult to injury, Mel had to pay income tax on the interest he earned on the GIC and savings account – an added tax bill of about $300 each year.

If you’re in a similar situation, and chances are you are, why not keep that money in your pocket? (Are you thinking about what you would do with that extra money? A trip to Cabo? A down payment on your bathroom renovation? Stop daydreaming! We still have a lot of work to do. You don’t have the money yet, but stay with me, and you soon will.)

With a line of credit that amalgamates all your debt and savings, the bottom line is always the bottom line, and it is staring you right in the face. Nobel Prize-winning economist Daniel Kahneman, one of the founders of the now popular field of behavioural finance, wrote about the phenomena of “mental accounts.” According to his work, “there is a behavioural phenomenon of not consolidating debt because of ‘Sticker Shock.’ ” In other words, we don’t consolidate our debt even when we know it could save us a significant amount of money on interest, because it is easier to cope mentally with smaller amounts in different accounts.

If you’re feeling a little woozy thinking about the $2,400 Mel and Molly were needlessly paying every year, you will want to sit down. Because that is nothing compared to the $27,000 in taxes Mel had needlessly paid. Yes, with $60,000 in unused contribution room, Mel paid Canada Revenue Agency $27,000 in unnecessary taxes – and lost the compound returns he would have enjoyed if he’d kept and invested the debt repayments.

Like Mel and Molly when I first outlined Dessanomics for them, you may be thinking that it is unrealistic to use your savings to pay off your line of credit; that you need money in savings for things like FOOD if you lose your job or something goes off the rails. You may also be thinking, like Mel and Molly, that if you had $60,000, you would definitely catch up on your RRSP contributions, but you just don’t have it.

That’s exactly the kind of thinking that keeps so many Canadians trapped in the same situation as Mel and Molly found themselves in: doing everything their financial advisers and bankers tell them to do, but never being able to create the results they want.

In a report released October, 2005, Dr. Moshe Milevsky of York University wrote, “Debt consolidation is not practised because the magnitude of the loss is not well understood.” That has been my experience as well. When I show my clients how much they could save by managing their debt more efficiently, they’re stunned. The magnitude of loss is massive.

To make the most of your money, it’s important to understand how balance sheets work. It’s pretty simple, and the math involved is elementary. But unless you’re a business owner, you’ve probably never thought about the importance of your personal balance sheet.

The concept is straightforward: you have two columns, one of assets and one of liabilities. The total (assets minus liabilities) is your net worth, a number that certainly concerns your bank. If your bank thinks it’s important, you should too. You want that number to grow as much as possible every year, and you want that growth to cost as little as possible. (That’s what we call efficient cash flow.)

ASSETS MINUS LIABILITIES = NET WORTH (A-L=NW)

ASSETS: In this column, you should list everything you own that has financial value. Keep it simple.

Minus

LIABILITIES: Now you need to add up all of the money you owe to anyone you need to pay off at some point in the future.

Equals

YOUR NET WORTH

Let’s look at the Young’s balance sheet.



SHORT TERM ASSETS

SHORT TERM LIABILITIE

$2,500 Cash - bank account



$18,000 Line of credit



$20,000 30 day GIC

$4,500 Credit card

LONG TERM ASSETS



LONG TERM LIABILITIES



$300,000 House market value

$125,000 Mortgage

$125,000 RRSP - Mel



$15,000 LIRA - Molly



$10,000 This year’s RRSP



$472,500 TOTAL ASSETS

$147,500 TOTAL LIABILITIES

ASSETS - LIABILITIES = TOTAL NET WORTH



$472,500 (ASSETS) - $147,500 (LIABILITIES) = $325,000 TOTAL NET WORTH







The Youngs had their debt in different accounts. They owed X on their mortgage, Y on their various credit cards and Z on their personal line of credit and car loans. Keeping everything in separate mental accounts may have been more emotionally comfortable, but it is comfort that no one can afford.

That looks pretty good, right?

But let’s narrow this down a bit to get to the heart of the problem. Let’s look just at the Young’s short-term assets and liabilities.



SHORT TERM ASSETS

(MINUS)

SHORT TERM LIABILITIES

$2,500Cash - bank account



$18,000 Line of credit

$20,000 30 day GIC



$4,500Credit card

$22,500 TOTAL ASSETS

(MINUS)

$22,500 TOTAL LIABILITIES

= 0.00 TOTAL NET WORTH







In other words, the Youngs were operating under the illusion that they had $22,500 in savings ($2,500 in the bank and $20,000 in short-term savings). Are you operating under a similar illusion?

The truth of the matter is the Youngs had nothing, because they owed the bank exactly that amount on their line of credit and credit card, and they were paying about $2,400 each year for that illusion.

If you think it through, it’s mind-boggling to realize that the bank is charging you interest AND making you make payments to them monthly on money that you don’t even owe. In addition to the unnecessary interest, Mel and Molly were paying approximately $5,100 per year ($425 per month) toward that debt, money they could have used for other things, all much more profitable or enjoyable.

Excerpted with permission. The Fireman and The Waitress by Dessa Kaspardlov, CEO of KL&A and creator of Dessanomics™

www.askdessa.com; www.dessanomics.com

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