I think you missed the part where I said $1100 was HALF of what it would cost to own a house. I pay half of the total rent, so I also assumed I would pay only half of the mortgage payment. If I owned the house alone, I would pay upwards of $2,200, and if I rented alone I would pay $630.
I'm not saying owning is a bad idea - on the contrary, there are many great reasons to buy - but when the rent/mortgage payment ratio is so skewed, it's not true that you necessarily save money by owning rather than renting.
Thanks for the article, I have been looking for someone to do a write-up on this! I recently started a company focused on providing cool eco and socially responsible clothing. I thought I would pass it along. www.sattlerclothing.com
Awesome comments, guys! I appreciate all the feedback. As is evidenced by this comment string, risk is very different for everybody, and quite a hot topic. I won't try to candy-coat the risk involved with leveraging....it's risky! I simply want people to know it is a strategy for businesses and wealth accumulation for people with stong stomachs.
re Interest Deductibility: Lex gave us a link about interest deductions for investments, and here is one for business investments. The relevant text on the page for eligible business deductions reads:
Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities.
@Guest (Not Entirely Accurate); You are right....I didn't delve into the taxation of the income, which in turn reduces effective returns. I felt it was beyond the scope of the article, but it is still relevant information nonetheless.
And in regards to the interest rates used, you're also right; the higher the interest rate the less appealling the strategy gets. I was using extremely simplistic numbers for the example just to illustrate the point.
But even using your numbers with an after-tax return of $2,680 on the initial $10,000 investment, you have a 26% return! I still think that's pretty good for suitable leverage candidates.
@Lex: Thanks for the link for interest deductibility on investment loans. You mention at the end that you feel that the vast majority (especially laymen) would get burned more often than not. I agree! Leverage is not for laymen looking for a cheap thrill. People who leverage are knowledgeable, and surround themselves with experts: accountants, business coaches, and financial planners. I would never expect that a DIYer could jump right into leveraging....just look at the number of knowledgeable people on this comment string who didn't know that interest on business and investment loans can be tax deductible! (mind you, it's not always tax-deductible.....that is a matter for the fine print in tax law). It is through the use and knowledge of experts that we can get ahead in life. It's too hard to do it all by yourself.
For all of you people who say that people will never reduce their driving, I say - THEY ALREADY DO!
I live in a suburb of a city. My house is about a mile from a light rail line. I work downtown. My son attends daycare downtown a few days a week. I drive on the days he goes to daycare. I park across the river where parking is cheaper and walk the rest of the way most days when I drive. On days when I'm sick or the weather is horrible, I park downtown. On the days when he is not in daycare, I walk to the train, take the train to work and home, and then walk home. (I hope that once my son gets a little older, I'll be able to take him on the train most days, too.)
I used to live across the river from dowtown - on nice days, I'd walk; on others, I'd take a bus; and when I was pregant and violently ill, I'd drive (but carpool).
As you can see, I'm not attached to driving, and a variety of factors influence the calculus of when I drive. If the cost of driving increased, I would certainly stop. The thing is, I'm not alone. The buses are ALWAYS more crowded when it rains, because people prefer that to walking in the rain. The train is more crowded on nice days, and the traffic is worse when it rains, because people don't like to walk to, and then wait for, a train in the rain. There are a lot of people who have flexible commute options, and make their choices based on a calculation of factors.
And if the simple inconvenience of RAIN can make people decide whether to drive, walk, or take public transit, MONEY will certainly be an ever bigger factor in their choice!
There are always an awful lot of women with families on my trains. Many of these women work as support staff and don't make a lot of money. At a certain point, if the cost of working gets too high, it doesn't make sense to keep working. These women aren't making a lot of money, so it doesn't make sense for them to buy, insure, fuel, and park a car just to get to their jobs when a train pass is so much cheaper (and can be paid for from your pre-tax income, mitigating your tax burden, too). If the cost of getting to work gets high enough, these women will drop out of the workforce if there's no affordable way to get there.
When the price of gas and parking goes up, more people take public transit. When the price of public transit increases, they lose ridership. Thus, as the price of transportation goes up, people like me with flexible commute options choose to NOT drive. It's not going to be hard to convince these people that driving is worth ditching in favor of cheap, reliable, fast, easily accessible public transit.
The problem, as the author says, is making sure such infrastructure is built. I am lucky to live in an area with fairly expansive public transportation, and I chose to buy a home within walking distance of my son's future school and a train that takes me to my job. My neighbors already know this is a valuable asset. More people need to start demanding to have access to the same.
Hey, thanks for taking the time to write. Two things:
1. If you're not overweight, and your A1C is in a good range, maybe there's something else getting to you? I don't experience pain as a result of my diabetes, and haven't heard of pain and exhaustion as a symptom of the disease, so have you talked to your doctor about this?
2. You adopted a sibling group. God bless you. I can't tell you how happy it makes me to read that. There are so few parents in the world who are willing to give that much of themselves.
But that's your PORTION of the rent. If you rented a house entirely to yourself, you'd be paying at least $1100 in Seattle to rent a home, if not more. Apples to apples.
With all due respect, I have always had some trouble with this kind of statement. I just don't see how full time daycare for a child equates to the daycare "raising" that child--as if the family or parents no longer do the raising, if that child is being looked after during a scheduled work day.
I attended full time family daycare from the time I was six weeks old. I only have glowing things to say about the daycares I attended. And while these experiences supplemented my upbringing and learning about the world--they in no way replaced the raising that my parents did!
Make no mistake: though a daycare supervised me during daylight/working hours, it was my parents who raised me---from loving things they showed me, to mistakes they made as well. THEY raised me. Daycare did not.
I know you are probably right. If I will exercise, I will feel better, thus then hopefully I will not need to take so many meds. In the end I get what I want; health and less meds.
But dang!!!!! I am not really overweight and my AIC is about 6.5 (probably now 7.5 with not taking meds so much) anyway, I just feel like a truck runs over me at night. My body hurts so much every morning, making it difficult to get up. We just recently adopted a 2 and 3 year old sibling group and it is hard to keep up with them physcially. I get so stressed and that just compounds this glorious adventure. I really don't think, if I had the option in another lifetime, to choose to have diabetes. I remember watching my mom fight this until she had a massive stroke and died. I remember being so mad at this disease that I thought, "Bring it on, I will kick your butt!!!" HAHAHAHA - look at me now :)
"If $25,000 seems like a loss, remember that she did enjoy use of that home for 2 years minimum. That's at least what it costs to rent a home for the same period of time."
That would be true if rent prices had been keeping pace with home prices, but they haven't - at least not where I live. In Seattle, I pay $320/month for my portion of rent. To buy the same size apartment in a similar neighborhood, I would pay upwards of $1,100/month towards my half of the mortgage.
I promise you, if you exercise, you will have more energy. It doesn't seem to make sense (you're tired, exerting yourself doesn't sound like fun) but trust me, insulin isn't going to make you feel better or healthier. It could help you control higher blood sugars, but it won't give you more energy.
I can sympathize with the overly-medicated feeling. Talk to your doctor. Go easy on the chromium because it can hurt your liver over time.
I am debating with myself about whether or not to take insulin. I have had type 2 diabetes for about 10 years. I know when I exercise, lose weight and eat right my blood sugar goes down. However, I have no energy to do any of this! Thus the reason for my self debate. I take meds: Metformin, Starlix and Actos ( I just added Chromium) for this wonderful condition. I am wondering if my body is so full of this synthetic crap that it makes my body ache all the time and keeps me tired.
if the government provided a tool so that one could personalize their inflation rate.
For example, I live in NYC and I am single, so my inflation rate is obviously different than a family of 5 in surburban Indianapolis, or even a single person with a child and car who lives in NYC.
So, you could check off what your expenses were based on lifestyle...in my case there would be no check for gasoline, but there would be for rent. Then, adjust for location and voila!
The CPI is useless. It has been massaged and manipulated by ever administration since LBJ, and for good reason. Payments to entitlement programs, like SS, are tabbed to the CPI. CPI is up, gov has to pay more out.
When the CPI is showing higher inflation figures than is comfortable, they simply change the way it's calculated. For example, housing prices have been left out for the past few years. If it wasn't inflation would be shown to be rampant. Instead they subsituted the price your house could rent for - a figure that hasn't kept up with home prices.
They make use of subsitution in many other areas. If the price of beef steak rises too much, they replace it with hamberger meat. The rational is that people would switch.
They use hedonics. They measure some things by their supposed productivity. For example, with a computer. A computer you can purchase for $2000 today is much more powerful than a computer purchased 5 years ago, therefore this is given much more weight in calculating the CPI. Even though the new computer is accomplishing much the same thing the old one did.
The CPI is pure scam, a scam most fall for. Inflation is nothing more than the amount of dollars in the system. More dollars in the system ultimately results in higher prices. More dollars chasing the same amount, or fewer, assets. The gov used to publish M3 figures which show the amount of dollars in the economy. They stopped doing that last march because it became an embarrassment. It showed how the gov is pumping the system full of trillons of dollars essentially created out of air.
If you want a real gauge of inflation, simply look at the cost of a postage stamp, hamberger or loaf of bread, or gold. Gold is an excellent barometer, it was selling at $260 in 1999 and now is $760, an increase of 200% in that time.
The CPI is useless. It has been massaged and manipulated by ever administration since LBJ, and for good reason. Payments to entitlement programs, like SS, are tabbed to the CPI. CPI is up, gov has to pay more out.
When the CPI is showing higher inflation figures than is comfortable, they simply change the way it's calculated. For example, housing prices have been left out for the past few years. If it wasn't inflation would be shown to be rampant. Instead they subsituted the price your house could rent for - a figure that hasn't kept up with home prices.
They make use of subsitution in many other areas. If the price of beef steak rises too much, they replace it with hamberger meat. The rational is that people would switch.
They use hedonics. They measure some things by their supposed productivity. For example, with a computer. A computer you can purchase for $2000 today is much more powerful than a computer purchased 5 years ago, therefore this is given much more weight in calculating the CPI. Even though the new computer is accomplishing much the same thing the old one did.
The CPI is pure scam, a scam most fall for. Inflation is nothing more than the amount of dollars in the system. More dollars in the system ultimately results in higher prices. More dollars chasing the same amount, or fewer, assets. The gov used to publish M3 figures which show the amount of dollars in the economy. They stopped doing that last march because it became an embarrassment. It showed how the gov is pumping the system full of trillons of dollars essentially created out of air.
If you want a real gauge of inflation, simply look at the cost of a postage stamp, hamberger or loaf of bread, or gold. Gold is an excellent barometer, it was selling at $260 in 1999 and now is $760, an increase of 200% in that time.
I think it is about the risk that involved. When we are investing with own money, the risk is to just lose what we've invested. If we are borrowing money to invest, it is like using our future income to invest. We might earn more, but on the other side, we are putting our future income at risk.
Sometimes Wise Bread is more informative than school! Thank you, Philip. As always, a useful, informative article which emphasizes areas people don't always know, but should!
Interest can be tax deductible on general loans if they're used to buy something that will generate dividends, royalties, annuities, or interest (See Passive Activity Loss for more information). There are several qualifications to deduct interest paid on monies borrowed to buy such items and you should probably consult a tax professional to ensure that you're going to meet all the qualifications if you decide to do it.
That being said, I still think it's foolish to borrow money to invest. Contrary to popular belief, there really is no such thing as a "sure thing" when it comes to investments. There's alway the possibility of loss, and when you discuss leveraging you also need to take into account risk. The amount of risk involves actually becomes a factor in your potential profit. So if you think there's a potential to make 10%, but there's significant risk, then statistically you would discover that in an average case you'll lose money despite the potential 10%.
There are some that can actually borrow money to invest and make money most of the time, but for the vast majority of people (especially laymen) I would tend to think that you'll get burned more often than not.
There are three things you need to pull apart to look at future expenses.
Inflation is actually the easiest, because it doesn't change the relative prices of things, it just changes what we call those prices. (That is, we used to call it $100 and now we call it $200, but it's really the same value in terms of the number of hours we have to work to pay for it or in terms of what other goods or services we could swap for it.)
The killers for predicting future costs are:
1) Changes in relative costs. Who would have figured that advances in technology, combined with manufacturing overseas would give us $49 DVD players? It was only 15 years ago that I spent over $100 on the absolute cheapest CD player available and figured I'd gotten the deal of a lifetime. Medical care has gotten vastly more expensive, but has also gotten a lot better. Housing has gotten more expensive without getting significantly better (except for getting bigger).
2) Changes in standard of living. Critical resources like oil are going to get more expensive, making us all poorer.
I think the best way to control your expenses going forward will be to own stuff (where you can) and to stay flexible (everyplace else). Stuff that you own is stuff that you don't have to worry about the future price of. Stuff that you can't own... you simply have to accept that you'll need to adjust to the future realities as far as buying it in the future--accept that you may have to make do with substitutes.
I wrote a bit a while back specifically about buying things now to take advantage of the cheap energy that's available now in a piece called Fix energy in tangible form.
I know this is a primer article and you as trying to give some simple examples but I still think the ones you do give are lacking. Let me explain using your example above:
I took out a $100,000 loan at 4% interest and within a year I make 8% back on my money. First of all, I didn't think that a personal loan was tax deductible so that means my 4% loan really is 4%! Anyways, my rate of return is 8% - 4% = 4% or $4,000 after one year. However, I'm subject to regular income tax because of the short term. Let's say I get taxed at 33%, which is equal to $1,320 of my $4,000 gain. That leaves me with a profit of $2,680 after everything is said and done. So much for my 50% return!
Just keep that in mind when leveraging. Sure you can make a lot of money, but you can also lose a lot as well. It's all about your own personal tolerance for risk.
By the way, I wish I could find a 4% interest rate for a loan. They're more like 7%-8% which would completely eliminate your gain.
Wow, negative Nancy! How do you think any investment bank does it - LEVERAGE!!! The return on investment is much greater, the more money you can put down. If the investment cash flows, it works! Yes, there is a big risk if the business or investment stops cash flowing. But a negative attitude is NOT going to get you that vacation home in the Hamptons (or where ever negative Nancys vacation).
The biggest thing that I think is missed, is that a business or investment ONLY has to pay the debt service. If the loan is on a short enough amortization, you earn large amounts of equity every single year you pay down debt. Therefore, if you have a 10 year am, you own half of the project outright after 5 years - not considering an appreciation in value. So, you sell! Plus, if your entire investment is in property or equipment, you can depreciate it and get a large tax benefit!!!
Understanding that nobody can predict the future, is there a index I can feel confident using in my financial planning to figure out what my lifestyle will cost me in 5, 10, 15 years?
I didn't think my comment was negative. You didn't say anything about holes and I looked into it. Thought I'd pass the info on, that's all -- don't de"spare". No need to go on strike. (sorry those were the best puns I could come up with...)
When Paul wrote about lateral thinking, I couldn't come up with any clever ideas; but I did realize that the wealthy tend to take more risks or rather they see opportunities and are willing to use debt. For example, someone may have the income to buy a second home or vacation home but borrow at low interest rates and then meet the mortgage and other expenses through rental so that positive cash flow is maintained. Then the income can be used for investments that can often return much more than the interest rate of your loan. Great thoughts on leveraging!
I also had the question about tax deductibility of interest. In the U.S., for individuals, interest on loans borrowed against your home (primary mortgages, refinances, home equity loans) is tax-deductible but other types of loans don't offer this benefit. But tax laws vary among countries and the right kind of business structure may allow this benefit as well.
Where I live, gasoline costs over $6 a gallon and have for years. This summer the cheapest gas (lowest octane number) was about $7 a gallon.
Five dollars for a gallon of gasoline is cheap. Very cheap.
I don't really care one way or another. It strikes me as pointless to change time to suit our needs. I do love the long summer evenings, though, I have to admit it. I just thought it was interesting that, although DST is pitched as an "energy-saving" idea, it's really all about getting us to spend more.
@Guest
I think you missed the part where I said $1100 was HALF of what it would cost to own a house. I pay half of the total rent, so I also assumed I would pay only half of the mortgage payment. If I owned the house alone, I would pay upwards of $2,200, and if I rented alone I would pay $630.
I'm not saying owning is a bad idea - on the contrary, there are many great reasons to buy - but when the rent/mortgage payment ratio is so skewed, it's not true that you necessarily save money by owning rather than renting.
Thanks for the article, I have been looking for someone to do a write-up on this! I recently started a company focused on providing cool eco and socially responsible clothing. I thought I would pass it along. www.sattlerclothing.com
Awesome comments, guys! I appreciate all the feedback. As is evidenced by this comment string, risk is very different for everybody, and quite a hot topic. I won't try to candy-coat the risk involved with leveraging....it's risky! I simply want people to know it is a strategy for businesses and wealth accumulation for people with stong stomachs.
re Interest Deductibility: Lex gave us a link about interest deductions for investments, and here is one for business investments. The relevant text on the page for eligible business deductions reads:
Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities.
@Guest (Not Entirely Accurate); You are right....I didn't delve into the taxation of the income, which in turn reduces effective returns. I felt it was beyond the scope of the article, but it is still relevant information nonetheless.
And in regards to the interest rates used, you're also right; the higher the interest rate the less appealling the strategy gets. I was using extremely simplistic numbers for the example just to illustrate the point.
But even using your numbers with an after-tax return of $2,680 on the initial $10,000 investment, you have a 26% return! I still think that's pretty good for suitable leverage candidates.
@Lex: Thanks for the link for interest deductibility on investment loans. You mention at the end that you feel that the vast majority (especially laymen) would get burned more often than not. I agree! Leverage is not for laymen looking for a cheap thrill. People who leverage are knowledgeable, and surround themselves with experts: accountants, business coaches, and financial planners. I would never expect that a DIYer could jump right into leveraging....just look at the number of knowledgeable people on this comment string who didn't know that interest on business and investment loans can be tax deductible! (mind you, it's not always tax-deductible.....that is a matter for the fine print in tax law). It is through the use and knowledge of experts that we can get ahead in life. It's too hard to do it all by yourself.
For all of you people who say that people will never reduce their driving, I say - THEY ALREADY DO!
I live in a suburb of a city. My house is about a mile from a light rail line. I work downtown. My son attends daycare downtown a few days a week. I drive on the days he goes to daycare. I park across the river where parking is cheaper and walk the rest of the way most days when I drive. On days when I'm sick or the weather is horrible, I park downtown. On the days when he is not in daycare, I walk to the train, take the train to work and home, and then walk home. (I hope that once my son gets a little older, I'll be able to take him on the train most days, too.)
I used to live across the river from dowtown - on nice days, I'd walk; on others, I'd take a bus; and when I was pregant and violently ill, I'd drive (but carpool).
As you can see, I'm not attached to driving, and a variety of factors influence the calculus of when I drive. If the cost of driving increased, I would certainly stop. The thing is, I'm not alone. The buses are ALWAYS more crowded when it rains, because people prefer that to walking in the rain. The train is more crowded on nice days, and the traffic is worse when it rains, because people don't like to walk to, and then wait for, a train in the rain. There are a lot of people who have flexible commute options, and make their choices based on a calculation of factors.
And if the simple inconvenience of RAIN can make people decide whether to drive, walk, or take public transit, MONEY will certainly be an ever bigger factor in their choice!
There are always an awful lot of women with families on my trains. Many of these women work as support staff and don't make a lot of money. At a certain point, if the cost of working gets too high, it doesn't make sense to keep working. These women aren't making a lot of money, so it doesn't make sense for them to buy, insure, fuel, and park a car just to get to their jobs when a train pass is so much cheaper (and can be paid for from your pre-tax income, mitigating your tax burden, too). If the cost of getting to work gets high enough, these women will drop out of the workforce if there's no affordable way to get there.
When the price of gas and parking goes up, more people take public transit. When the price of public transit increases, they lose ridership. Thus, as the price of transportation goes up, people like me with flexible commute options choose to NOT drive. It's not going to be hard to convince these people that driving is worth ditching in favor of cheap, reliable, fast, easily accessible public transit.
The problem, as the author says, is making sure such infrastructure is built. I am lucky to live in an area with fairly expansive public transportation, and I chose to buy a home within walking distance of my son's future school and a train that takes me to my job. My neighbors already know this is a valuable asset. More people need to start demanding to have access to the same.
Hey, thanks for taking the time to write. Two things:
1. If you're not overweight, and your A1C is in a good range, maybe there's something else getting to you? I don't experience pain as a result of my diabetes, and haven't heard of pain and exhaustion as a symptom of the disease, so have you talked to your doctor about this?
2. You adopted a sibling group. God bless you. I can't tell you how happy it makes me to read that. There are so few parents in the world who are willing to give that much of themselves.
But that's your PORTION of the rent. If you rented a house entirely to yourself, you'd be paying at least $1100 in Seattle to rent a home, if not more. Apples to apples.
With all due respect, I have always had some trouble with this kind of statement. I just don't see how full time daycare for a child equates to the daycare "raising" that child--as if the family or parents no longer do the raising, if that child is being looked after during a scheduled work day.
I attended full time family daycare from the time I was six weeks old. I only have glowing things to say about the daycares I attended. And while these experiences supplemented my upbringing and learning about the world--they in no way replaced the raising that my parents did!
Make no mistake: though a daycare supervised me during daylight/working hours, it was my parents who raised me---from loving things they showed me, to mistakes they made as well. THEY raised me. Daycare did not.
I know you are probably right. If I will exercise, I will feel better, thus then hopefully I will not need to take so many meds. In the end I get what I want; health and less meds.
But dang!!!!! I am not really overweight and my AIC is about 6.5 (probably now 7.5 with not taking meds so much) anyway, I just feel like a truck runs over me at night. My body hurts so much every morning, making it difficult to get up. We just recently adopted a 2 and 3 year old sibling group and it is hard to keep up with them physcially. I get so stressed and that just compounds this glorious adventure. I really don't think, if I had the option in another lifetime, to choose to have diabetes. I remember watching my mom fight this until she had a massive stroke and died. I remember being so mad at this disease that I thought, "Bring it on, I will kick your butt!!!" HAHAHAHA - look at me now :)
Thanks for listening!
@Linsey Knerl
"If $25,000 seems like a loss, remember that she did enjoy use of that home for 2 years minimum. That's at least what it costs to rent a home for the same period of time."
That would be true if rent prices had been keeping pace with home prices, but they haven't - at least not where I live. In Seattle, I pay $320/month for my portion of rent. To buy the same size apartment in a similar neighborhood, I would pay upwards of $1,100/month towards my half of the mortgage.
I promise you, if you exercise, you will have more energy. It doesn't seem to make sense (you're tired, exerting yourself doesn't sound like fun) but trust me, insulin isn't going to make you feel better or healthier. It could help you control higher blood sugars, but it won't give you more energy.
I can sympathize with the overly-medicated feeling. Talk to your doctor. Go easy on the chromium because it can hurt your liver over time.
I am debating with myself about whether or not to take insulin. I have had type 2 diabetes for about 10 years. I know when I exercise, lose weight and eat right my blood sugar goes down. However, I have no energy to do any of this! Thus the reason for my self debate. I take meds: Metformin, Starlix and Actos ( I just added Chromium) for this wonderful condition. I am wondering if my body is so full of this synthetic crap that it makes my body ache all the time and keeps me tired.
Any thoughts?????
if the government provided a tool so that one could personalize their inflation rate.
For example, I live in NYC and I am single, so my inflation rate is obviously different than a family of 5 in surburban Indianapolis, or even a single person with a child and car who lives in NYC.
So, you could check off what your expenses were based on lifestyle...in my case there would be no check for gasoline, but there would be for rent. Then, adjust for location and voila!
Keep the asskicking posts coming, Philip!
The CPI is useless. It has been massaged and manipulated by ever administration since LBJ, and for good reason. Payments to entitlement programs, like SS, are tabbed to the CPI. CPI is up, gov has to pay more out.
When the CPI is showing higher inflation figures than is comfortable, they simply change the way it's calculated. For example, housing prices have been left out for the past few years. If it wasn't inflation would be shown to be rampant. Instead they subsituted the price your house could rent for - a figure that hasn't kept up with home prices.
They make use of subsitution in many other areas. If the price of beef steak rises too much, they replace it with hamberger meat. The rational is that people would switch.
They use hedonics. They measure some things by their supposed productivity. For example, with a computer. A computer you can purchase for $2000 today is much more powerful than a computer purchased 5 years ago, therefore this is given much more weight in calculating the CPI. Even though the new computer is accomplishing much the same thing the old one did.
The CPI is pure scam, a scam most fall for. Inflation is nothing more than the amount of dollars in the system. More dollars in the system ultimately results in higher prices. More dollars chasing the same amount, or fewer, assets. The gov used to publish M3 figures which show the amount of dollars in the economy. They stopped doing that last march because it became an embarrassment. It showed how the gov is pumping the system full of trillons of dollars essentially created out of air.
If you want a real gauge of inflation, simply look at the cost of a postage stamp, hamberger or loaf of bread, or gold. Gold is an excellent barometer, it was selling at $260 in 1999 and now is $760, an increase of 200% in that time.
What's next, possibly hyperinflation.
The CPI is useless. It has been massaged and manipulated by ever administration since LBJ, and for good reason. Payments to entitlement programs, like SS, are tabbed to the CPI. CPI is up, gov has to pay more out.
When the CPI is showing higher inflation figures than is comfortable, they simply change the way it's calculated. For example, housing prices have been left out for the past few years. If it wasn't inflation would be shown to be rampant. Instead they subsituted the price your house could rent for - a figure that hasn't kept up with home prices.
They make use of subsitution in many other areas. If the price of beef steak rises too much, they replace it with hamberger meat. The rational is that people would switch.
They use hedonics. They measure some things by their supposed productivity. For example, with a computer. A computer you can purchase for $2000 today is much more powerful than a computer purchased 5 years ago, therefore this is given much more weight in calculating the CPI. Even though the new computer is accomplishing much the same thing the old one did.
The CPI is pure scam, a scam most fall for. Inflation is nothing more than the amount of dollars in the system. More dollars in the system ultimately results in higher prices. More dollars chasing the same amount, or fewer, assets. The gov used to publish M3 figures which show the amount of dollars in the economy. They stopped doing that last march because it became an embarrassment. It showed how the gov is pumping the system full of trillons of dollars essentially created out of air.
If you want a real gauge of inflation, simply look at the cost of a postage stamp, hamberger or loaf of bread, or gold. Gold is an excellent barometer, it was selling at $260 in 1999 and now is $760, an increase of 200% in that time.
What's next, possibly hyperinflation.
I think it is about the risk that involved. When we are investing with own money, the risk is to just lose what we've invested. If we are borrowing money to invest, it is like using our future income to invest. We might earn more, but on the other side, we are putting our future income at risk.
Sometimes Wise Bread is more informative than school! Thank you, Philip. As always, a useful, informative article which emphasizes areas people don't always know, but should!
Interest can be tax deductible on general loans if they're used to buy something that will generate dividends, royalties, annuities, or interest (See Passive Activity Loss for more information). There are several qualifications to deduct interest paid on monies borrowed to buy such items and you should probably consult a tax professional to ensure that you're going to meet all the qualifications if you decide to do it.
That being said, I still think it's foolish to borrow money to invest. Contrary to popular belief, there really is no such thing as a "sure thing" when it comes to investments. There's alway the possibility of loss, and when you discuss leveraging you also need to take into account risk. The amount of risk involves actually becomes a factor in your potential profit. So if you think there's a potential to make 10%, but there's significant risk, then statistically you would discover that in an average case you'll lose money despite the potential 10%.
There are some that can actually borrow money to invest and make money most of the time, but for the vast majority of people (especially laymen) I would tend to think that you'll get burned more often than not.
There are three things you need to pull apart to look at future expenses.
Inflation is actually the easiest, because it doesn't change the relative prices of things, it just changes what we call those prices. (That is, we used to call it $100 and now we call it $200, but it's really the same value in terms of the number of hours we have to work to pay for it or in terms of what other goods or services we could swap for it.)
The killers for predicting future costs are:
1) Changes in relative costs. Who would have figured that advances in technology, combined with manufacturing overseas would give us $49 DVD players? It was only 15 years ago that I spent over $100 on the absolute cheapest CD player available and figured I'd gotten the deal of a lifetime. Medical care has gotten vastly more expensive, but has also gotten a lot better. Housing has gotten more expensive without getting significantly better (except for getting bigger).
2) Changes in standard of living. Critical resources like oil are going to get more expensive, making us all poorer.
I think the best way to control your expenses going forward will be to own stuff (where you can) and to stay flexible (everyplace else). Stuff that you own is stuff that you don't have to worry about the future price of. Stuff that you can't own... you simply have to accept that you'll need to adjust to the future realities as far as buying it in the future--accept that you may have to make do with substitutes.
I wrote a bit a while back specifically about buying things now to take advantage of the cheap energy that's available now in a piece called Fix energy in tangible form.
Sorry I don't have a number for you.
Nora,
I know this is a primer article and you as trying to give some simple examples but I still think the ones you do give are lacking. Let me explain using your example above:
I took out a $100,000 loan at 4% interest and within a year I make 8% back on my money. First of all, I didn't think that a personal loan was tax deductible so that means my 4% loan really is 4%! Anyways, my rate of return is 8% - 4% = 4% or $4,000 after one year. However, I'm subject to regular income tax because of the short term. Let's say I get taxed at 33%, which is equal to $1,320 of my $4,000 gain. That leaves me with a profit of $2,680 after everything is said and done. So much for my 50% return!
Just keep that in mind when leveraging. Sure you can make a lot of money, but you can also lose a lot as well. It's all about your own personal tolerance for risk.
By the way, I wish I could find a 4% interest rate for a loan. They're more like 7%-8% which would completely eliminate your gain.
Wow, negative Nancy! How do you think any investment bank does it - LEVERAGE!!! The return on investment is much greater, the more money you can put down. If the investment cash flows, it works! Yes, there is a big risk if the business or investment stops cash flowing. But a negative attitude is NOT going to get you that vacation home in the Hamptons (or where ever negative Nancys vacation).
The biggest thing that I think is missed, is that a business or investment ONLY has to pay the debt service. If the loan is on a short enough amortization, you earn large amounts of equity every single year you pay down debt. Therefore, if you have a 10 year am, you own half of the project outright after 5 years - not considering an appreciation in value. So, you sell! Plus, if your entire investment is in property or equipment, you can depreciate it and get a large tax benefit!!!
Debt is not the enemy - improper use of debt is.
Understanding that nobody can predict the future, is there a index I can feel confident using in my financial planning to figure out what my lifestyle will cost me in 5, 10, 15 years?
I didn't think my comment was negative. You didn't say anything about holes and I looked into it. Thought I'd pass the info on, that's all -- don't de"spare". No need to go on strike. (sorry those were the best puns I could come up with...)
When Paul wrote about lateral thinking, I couldn't come up with any clever ideas; but I did realize that the wealthy tend to take more risks or rather they see opportunities and are willing to use debt. For example, someone may have the income to buy a second home or vacation home but borrow at low interest rates and then meet the mortgage and other expenses through rental so that positive cash flow is maintained. Then the income can be used for investments that can often return much more than the interest rate of your loan. Great thoughts on leveraging!
I also had the question about tax deductibility of interest. In the U.S., for individuals, interest on loans borrowed against your home (primary mortgages, refinances, home equity loans) is tax-deductible but other types of loans don't offer this benefit. But tax laws vary among countries and the right kind of business structure may allow this benefit as well.
Where I live, gasoline costs over $6 a gallon and have for years. This summer the cheapest gas (lowest octane number) was about $7 a gallon.
Five dollars for a gallon of gasoline is cheap. Very cheap.
I don't really care one way or another. It strikes me as pointless to change time to suit our needs. I do love the long summer evenings, though, I have to admit it. I just thought it was interesting that, although DST is pitched as an "energy-saving" idea, it's really all about getting us to spend more.