Debt Elimination - Don"t Be Burnt, Understand Your Spending
Debt is like fire, if you use it correctly then it can be of great benefit to you, heating and cooking, but used incorrectly it will burn you! Prior to the global financial disaster of late 2007 the markets had been racing ever upwards and housing prices appeared to be going through the roof.
The result of these boom years was for increased household spending and credit card debt because of misplaced confidence in the future of our economies.
But as history has shown repeatedly, all good things come to an end.
There are always financial cycles, but this cycle ended strongly and caused financial difficulties all around the world.
One group of people caught out were home owners who wanted to invest further in the real estate or stock markets.
They were convinced by slick financial salesmen that the equity in their homes was just tied up and going to waste.
To further add to their problems the equity was used to purchase leverage.
e.
g.
if I took $100,000 of equity out of my home loan I could buy the same value of stocks.
My risk would be my investment and it would be extremely unlikely to lose the lot.
The market in some countries fell about 50%, so my loss would have been limited to $50,000 But by using the same $100,000 I could have bought as much as $2,000,000 of stocks, -if they were blue chip stocks-using margin loans.
Its just like taking a loan and using a deposit.
Of course the investors simply thought the market would keep on going up.
In the above example when the market dropped 50% the loss on $2,000,000 would have been $1,000,000.
The margin lenders are not your friends when you take a big loss.
They want their money and they want it now.
For the investors most of them lost their home and many lost all their assets and were still in debt.
A common factor for most of the investors was that they were baby boomers and have retired or nearing retirement, now without their life savings.
Of course the market rebounded about 50% from the lows which equals a 25% recovery.
In the first example of no leverage the loss would have been reduced to $25,000 providing they didn't panic and sell at the bottom of the market.
Eventually they would make their money back.
They would still have been burned by their experienced, as that money tied up in the stocks may have no earning capacity for several years.
The group which had the high leverage did not have an opportunity to recoup their losses as the margin lenders step in straight away to recoup what they can.
Margin lending can be a good form of debt in a rising market, but you should never take more than 50% leverage, this gives you a lot of room to move before your loan is called in.
The result of these boom years was for increased household spending and credit card debt because of misplaced confidence in the future of our economies.
But as history has shown repeatedly, all good things come to an end.
There are always financial cycles, but this cycle ended strongly and caused financial difficulties all around the world.
One group of people caught out were home owners who wanted to invest further in the real estate or stock markets.
They were convinced by slick financial salesmen that the equity in their homes was just tied up and going to waste.
To further add to their problems the equity was used to purchase leverage.
e.
g.
if I took $100,000 of equity out of my home loan I could buy the same value of stocks.
My risk would be my investment and it would be extremely unlikely to lose the lot.
The market in some countries fell about 50%, so my loss would have been limited to $50,000 But by using the same $100,000 I could have bought as much as $2,000,000 of stocks, -if they were blue chip stocks-using margin loans.
Its just like taking a loan and using a deposit.
Of course the investors simply thought the market would keep on going up.
In the above example when the market dropped 50% the loss on $2,000,000 would have been $1,000,000.
The margin lenders are not your friends when you take a big loss.
They want their money and they want it now.
For the investors most of them lost their home and many lost all their assets and were still in debt.
A common factor for most of the investors was that they were baby boomers and have retired or nearing retirement, now without their life savings.
Of course the market rebounded about 50% from the lows which equals a 25% recovery.
In the first example of no leverage the loss would have been reduced to $25,000 providing they didn't panic and sell at the bottom of the market.
Eventually they would make their money back.
They would still have been burned by their experienced, as that money tied up in the stocks may have no earning capacity for several years.
The group which had the high leverage did not have an opportunity to recoup their losses as the margin lenders step in straight away to recoup what they can.
Margin lending can be a good form of debt in a rising market, but you should never take more than 50% leverage, this gives you a lot of room to move before your loan is called in.
