I read last week that JC Penney declared bankruptcy.
The Texas-based retailer had a 118 year run. That’s an incredible record in any industry.
But it’s problems were many…Seen as out of touch with the latest fashions and trends, operational missteps and getting trounced by Amazon and other retailers seen as more cutting edge.
While those are certainly formidable challenges, they’re not the real reason JC Penney declared bankruptcy. As I read the article, I was waiting for the real reason to appear.
And there, in the third paragraph down, I finally saw it….what ended JC Penney’s tenure…
The company had $4 billion in debt.
Four billion dollars.
Four billion hurdles.
Four billion obstacles.
Four billion IOU’s.
It takes a concerted effort to rack up that amount of financial pain. That deep of a financial hole is not dug overnight. Indeed, JC Penney steadfastly built that huge amount of leverage over many years.
Which makes one wonder…why didn’t someone put a stop to it earlier?
Why didn’t the CEO and Board put a stop to the increasing indebtedness when their debt load was in the tens of millions?
Why didn’t someone raise alarms and put an end to adding more leverage when their debt skyrocketed to $1 billion?
I’ll answer my own question.
Because America is addicted to debt, both at the corporate level and the personal level.
Total consumer debt hit just below $4.2 trillion in November 2019 according to the Federal Reserve. Collectively, Americans owe a whopping 10 percent of their disposable income to non-mortgage debts like car loans, credit card accounts and student or personal loans. Estimates are that nearly every American family (87%) is in debt.
What drives this behavior? Some studies have shown that Americans are losing their financial literacy at an alarming rate. These studies, which cover topics like basic finance and investment, show that Americans lack fundamental knowledge in these areas.
But I don’t buy that.
I find it hard to believe that grown men and women who operate computers, drive vehicles and help their children with their geometry homework are just ignorant of the pitfalls of debt.
I think the real answer is this…debt is addictive.
Debt is an easy drug to take, so many turn to it when they’re in financial trouble. The piggy bank has replaced the dog as man’s best friend.
And its effects are generally felt in small “bites” over time (convenient monthly payments), which makes the debt recipient even more blind as to it’s consequences. The chains of bad habits are too light to be felt until they are too heavy to be ignored.
At the recent Berkshire Hathaway annual shareholder’s meeting, legendary investor Warren Buffett to the time to address America’s issue with debt…
Recalling a discussion with one of his friends, who came for his advice on what to do with the money she had. Warren Buffett said, he asked her what she owes to her credit card.
The interest rate the woman was paying on her credit card was around 18%, recalled Buffett. “I don’t know how to make 18%. If I owe money with 18% interest, the first thing I would do with any money I have is to pay it (credit card payment due). It’s gonna be way better than any investment idea I have got,” he said.
Buffet further recalled that later on in the conversation when the lady asked about what she should let her daughter do with the $1,000-2,000 she had, he advised her to let her daughter lend the money to you (Buffett’s friend). “Have her lend it to you. If you are willing to pay 18%, she is not gonna find a better deal. “, said the investor.
“You can’t go through life, borrowing money at those rates and be better off. So, I encourage everybody and it’s contrary to Berkshire’s interest in certain cases and in the world with love in the credit cards… I would suggest to anybody that the first thing they do in life is that they can get something else later on, but don’t be paying even 12% to anybody, just pay that off…,” said Buffett.
Indeed. With debt of any kind, it’s important to look at it this way – your money is compounding away from you at the interest rate which you pay. That’s why Buffett said the first thing he’d do is pay off the debt.
Here’s a shorthand way to look at debt…
Whatever interest rate you’re charged, that’s the rate of return you’ll need to earn just to get back to where you started. Simply put, you need to not only pay the interest, but also earn replacement dollars to replace the ones you’ve lost to interest.
Paying 10% interest for that loan? You’ll need to earn 10% on your future money just to get back to where you started.
Paying 20% on that credit card balance? You’ll need to earn 20%.
That’s what Buffett was saying when he states “I don’t know how to make 18%”. Nobody can get ahead in life with their money compounding away from them at such high rates.
Friends, debt has become the new penicillin. It’s the cure-all that is reached for so easily, before considering other, healthier alternatives.
My advice is to make yourself allergic to debt. That will force you to take financially better choices, such as:
- Just forgoing the expense. Unless it’s a car or house, if you can’t pay cash for it you can’t afford it. Just say no to anything that would cause you to incur unnecessary debt. This is what JC Penny should have done many years ago. Blinded by easy the “remedy” of taking on debt, the company ran itself into bankruptcy. So many others have done this on a personal level. What’s ironic about bankruptcy is that a federal judge ends up doing what a person won’t do for themselves – cut expenses and get on a budget. For all the talk I hear about people wanting to be financially independent, it’s the mark of financial dependence when other adults must do a person’s financial business for them. It’s the ultimate sign that a person is not independent.
- Find other ways to make additional income if you can’t afford what you want. Because debt is such an easy drug to take, many debtors don’t even lift a finger to its alternative – making more money. Yes, this is more of a challenge than just buying something on credit, but which would you rather be challenged by – soul crushing debt or finding a way to increase your earning power? The former will leave you a mindless drone cowering to a credit card company. The latter will bolster your way of living while forging an indomitable spirit to accomplish your other goals.
I see many people and companies use debt thinking they can just pay for it later on. They believe that debt is their hero, providing them financial security. This a false sense of financial security that leads to just the opposite – no control over expenses and therefore no security.
A person or company that doesn’t control their expenses will never be wealthy. Borrowed money is not your money. That’s why it’s called OPM (other people’s money) and why it conveniently sounds like a drug. Just say no to it like you would any drug. Save your money and invest wisely and then you can get the best drug out there – financial freedom.
Be free. Nothing else is worth it.
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