Living Within Your Means: Advice to Graduate

You have just achieved something huge; you've worked hard for this; you've spent a significant portion of your life targeted at this one particular goal. For the high school graduate, this is probably the most significant long term goal that you've accomplished at this point in your life. For the college graduate, this is the most significant goal since you graduated from high school, most likely.

There are two schools of thought when it comes to personal finances and how you spend your money. In a nutshell, one philosophy is that you only buy something if you have the money to back it up (with the possible exception of a house with a mortgage; more on that below). This is the "No Debt" philosophy. The other philosophy is that it is okay to buy what you need when you need it, borrowing money to pay for it if necessary. This is the "Debt Is Okay" philosophy.

The "No Debt" approach is to never purchase anything on credit if you don't already have the liquid assets to be able to pay for it. In other words, use the credit card as a convenience, not as a bridge to cover the gap until your next paycheck comes in.

So, for example, suppose you have $8000 in the bank, and you determine that you need to buy a car. The "No Debt" philosophy says that you will buy a car for $8000 or less (and you will pay for it all up front, avoiding monthly car payments).

A modified version of this approach is that it is okay to get a home mortgage (i.e., borrowing money) as long as you are able to pay off your mortgage each month. The rule of thumb I've heard on this is that your mortgage payment should not be more than 25% of your take home pay, with the mortgage rate set to a 15 year fixed rate.

The "Debt Is Okay" approach argues that it is okay to borrow money to pay for something, especially if your savings is invested somewhere and is earning a larger rate of return than the rate you're paying for the money you borrowed (which is either the rate that your credit card charges or the rate you're paying for dealer financing, such as with monthly car payments).

This approach means that you can buy a more expensive car, but that you will be making monthly car payments.

There are a couple problems with the "Debt Is Okay" mentality though.

First, the consumer tends to get into the habit of saying, "I need it so I'll buy it." The discipline of carefully scrutinizing whether the purchase is needed can all too easily be thrown out the window. Frugality and a conservative lifestyle can get tossed by the wayside, making the saving and accumulating of wealth more difficult.

Second, once a consumer goes into debt, it gets harder and harder to get back out. Credit cards are notoriously bad for having horrific interest rates. If you don't pay off your credit card bill each month, it's going to build up in a hurry and you will always have that debt hanging over your head.

Since day one of our marriage, my wife and I have carried the "No Debt" philosophy. If we can't afford it, we don't buy it.

Sometimes it means going without; sometimes it means buying something used instead of new; but it also means that we never have a debt hanging over our heads.

I urge you, no matter what it is, if you don't have the money to pay for it, don't buy it. Do yourself a favor and stay out of debt. Your frugality will help you in the long run, perhaps even allowing you to save enough so that eventually you can purchase those more luxurious things if you so choose.

But if you go into debt now, you are creating a situation that could be a source of stress and hardship for years to come.

The choice is easy, isn't it?