You’re Buying A What?!
Why is this? It is socially acceptable to purchase luxury goods and enter into contracts paying relatively high interest rates for them, but yet buying an income-producing asset is met with such disbelief? If we had purchased a rental property, there would have been some words of caution no doubt, but probably far less of a reaction than purchasing a website. Again, this is interesting to me. From what I can tell, the average perception of risk is quite different than the one I have. So either I am completely wrong and will end up biting off way more than I can chew or, many of us are little mixed up in regards to how money and risk are used.
I Deserve It, Just Ask Visa
Purchasing luxury goods is not an intelligent risk, yet is generally accepted in society. Going into debt to pay for these luxury goods is also fairly common. For transactions that appear to be straight capital-for-pleasure trades, the marketing industry appears to have convinced us that we can never have too much, and that we deserve everything we can get our hands on. This of course leads to that weird lifestyle inflation phenomenon we all know and love. I must be wired differently, because I get way more of a jolt out of buying an asset than I do from buying something to wear, or drive, etc. This is not to say I’m overly cheap (although I may be). I like to pay for experiences, trips, going out with friends etc., but going into debt for luxury goods is not my thing.
My Best Investment Is My Home *gulp*
Many people who believe they know their way through day-to-day personal finance would strongly agree that going into large amounts of debt for a home mortgage (500% leverage anyone?) or for a rental property is a good investment. You can touch a home, feel a home, and the business model is very common. This is obviously intelligent risk right? I mean home rates always go up, renting property is totally passive since home maintenance is almost non-existent, what could go wrong? Paying the carrying costs on mortgages is an intelligent risk, while the carrying costs on a relatively small investment loan is insane if it’s used to buy a blog right? See where I am going here?
The Difference Between Good Risk and Bad Risk
Many of the things we believe are good risks such buying a “luxury toy” like a boat, or a new vehicle aren’t risks at all, they are merely buying something that has no way to generate cash (and will just leak value forever). Other things we believe that are considered intelligent risks include certain types of investment loans to buy real estate, or to purchase a piece of equipment for your business to make use of. To me, the bottom line on intelligent vs non-intelligent risk of your money/capital is: do you understand how your risk will pay off and do you understand the size of your risk?
If you understand the industry, you have a solid grasp on how profits are made and what “best practice” is within the field, then you can be confident that you continue to operate the asset your buying in an efficient fashion. If you believe that your risk-reward ratio carries a return on investment that is greater than 15%, then you are also in good company (the stock market by comparison has historically returned around 10%, and lately, much less than that). Finally, if you understand just how much money you are borrowing, relative to the expected income of your purchase, then you are well on your way to determining the difference between intelligent and non-intelligent risk in my opinion. If we step back a look objectively at mortgages, they are often just a socially acceptable way of leveraging your money in a massive way. There are plenty of lenders out there willing to hand out mortgages with 5% down if you have a decent credit history. That is 20-1 leverage, or 2000%!! If the housing market dips at all, you can lose massive amounts of net worth in a very short time. Yet five years ago a mortgage would have been considered a very smart risk if any risk at all.
Common Sense Makes You Average By Definition
Try not to let “common sense” money practices cloud your impression of what good and bad risk is. I find common sense a great guide in most aspects of life, but in terms of money and capital management, it has led many astray. People rarely go wrong investing in things that produce income, and are also assets that they understand. On the other hand, plenty of people go wrong when debt is used to fund luxurious tastes and overextending ourselves through social acceptable means.