Is the American Dream Dead? I hope so!

If you had asked any random American in the spring of 2008 how they defined the “American Dream,” you would probably hear something to the effect of owning a house with a white picket fence, a few children running around the yard with a dog, and a BMW for him and a Honda Odyssey for her parked in the driveway. Fast forward a few years to the summer of 2011 and that same person may have a slightly different answer. It’s not that people don’t want the same types of things as they did prior to the recent downturn in the economy, it’s just that the thick veil of unreality that had clouded the eyes of millions of Americans for years suddenly became a little bit thinner.

For tens of thousands, the American Dream was achieved not by years of conservative spending habits and prudent investing, but rather a no-limits bared consumption lifestyle fueled by easy credit and people’s unwillingness to use the word “no” to stuff. “Should I buy a 3rd pair of shoes this month even though I have 5 like them at home?” Yes! “Should I buy a new Ford F-250 truck even though I’m not a contractor and I commute 35-minutes to downtown each day?” Sure! “Should I take out a HELOC to fund that $50,000 gourmet kitchen I’ve always dreamed of despite the fact that 99% of my cooking involves the microwave?” Of course I should! “Should I buy this home that’s 3 times larger than I need, with no money down and an adjustable mortgage due to adjust in 36 months?” Absolutely!

These examples may be comical to a degree but a quick step back a few years and that was reality for many people. “Let the good times roll” was the prevailing attitude for the masses and the result was the inevitable crash we all had the privilege to walk through. As our glass-house perceptions of reality came crashing down all around us, we adamantly cried “never again, I’ll do it differently next time.” Fiscal responsibility chatter started flooding in from the white houses of Main Street to the slightly larger White House on 1600 Pennsylvania Avenue. At last, everyone seemed to be reading the Tortoise and the Hare again and desiring to morph their lives to resemble that of the Tortoise.

Though the mess isn’t over for everyone yet, there are enough positive changes from the job and stock markets alike to see that a recovery is in progress. Life is returning to what many people would call normality;  in doing so, I wonder if all those people who begged to become the Tortoise, if given the 2nd chance, are doing so? I’m curious what lessons have really been learned during the down times? Have behaviors really changed? Do we really intend to be more watchful of our spending habits? Have our investment strategies sincerely become more conservative? Have the methods for obtaining the American Dream, at least the pre-recession versions, really died? I hope so for all of our sake. Otherwise, we’ll be right back in this position within a decade if not sooner.

Is Debt Really a “Tool”?

I’m certain that everyone reading this post has heard the phrase “debt is a tool”. It is frequently used by financial “experts” and other “professionals” to help rationalize their belief that debt is a good means to an end. After all, you’re using someone else’s money right? Numerous financial planners, analysis, and guru’s stress the importance of using debt to your advantage through investments to increase your net worth and bottom-line. If you would have asked me a few years back I may have agreed 100% with the “debt is a tool” philosophy, but my position has changed in many regards….and here’s why.

People who believe that debt is a tool reason that by using somebody else’s money when investing allows you to speed up the wealth “accumulation” element of your net worth. More simply, why not take a loan out at 7% and invest the money into something that returns 10% or more? Isn’t that netting you at least a 3% return on your money, money you wouldn’t have had otherwise? Well if you stop the equation right there then yes, you would make out pretty good. But what about the other elements that come with using other peoples money?

If you are going to argue this philosphy from  a savvy financial position than you have to factor in elements such as taxes, risk, and logic. Say you are going to tap your homes equity and place the funds into an investment you believe will return you 12% annually, and the cost for the loan is 7% annually. That gives you a “free” 5% of profit right? Wrong! You pay taxes don’t you? Taxes on that 12% gain will cost you about 2.5% of the profits, lowering your annual return to about 2.5%. “I can live with that…after all, its free money!” Well, we aren’t done quite yet. A savvy financial investor ALWAYS has to consider risk. There are complex formulas that allow mathematicians and financial analysts to factor risk into investment equations, but the bottom-line is that you’d break even in this situation at best.

Sure, there is risk in everything we do and risk by itself doesn’t make an investment good or bad, but when the investment we are considering is funded solely on the debt the risk is considerably greater. In our example of using home equity to fund an investment, what if the investment goes down in flames and now you have two payments (or one larger payment) that push your budget out of whack? Are you willing to wager equity in your home or business for 2.5% of free money? How about the stress that accompanies a poor performing investment? Are you ready to sacrifice a good nights rest and financial peace in your marriage over 2.5% of free money?  Unfortunately many people are, as thousands of people do just that each day in our country. Of course, many of these people are eternal optimists that are shooting for returns 15%, 25%, or doubling there investment. However, the greater the potential return, the greater the actualrisk (Especially considering that anything promising returns that are abnormally high is typically to good to be true, and optimistic at best!).

I’m not against taking financial risks or shooting for big returns on your money, as I take them on mine everyday. I’m simply offering a word of caution and hopefully adding a few drops of realism to your investing methods. Personally, I’ve made investments using “my money” and “other people’s money”, and the times that the funds weren’t “mine” always led to some degree of stress, loss, or heartache. Sometimes all three. So tread carefully when considering who’s money you are going to use when making that next investment.