Tale of Two Tellers - Part VI
We began with a simple example. You walk into a bank, you give money to one teller and you borrow money from the other teller. This is happening every day when you transact and exchange money - the bank just might be a local coffee store, or a place you grab lunch.
You walk into a Starbucks and you pay $5 for a nice coffee. Enjoy it! You worked hard for the $5 and you had to likely perform some work for that $5. That work is stored in this thing we call money. You release that energy again when you spend it by trading that $5 (which is just a piece of paper or some 1's and 0's in the ether) into something you really want - coffee!!!
That coffee makes an experience happen, you feel warm, excited, etc. The coffee itself is rarely what you want, it is the experience you have with the coffee that you really want. (more on this in our next post as we talk about House-vs-Home).
When you trade that $5 for the coffee, you get the coffee. You also lose something. You lose every other possible use of that $5 (anything it could have bought, and anything it could have earned).
Remember, if you have an extra $5 in your pocket you can Spend, Save, or Repay. The choice to buy coffee is a Spend decision. I'm speaking in small terms here because these small decisions are simply small decisions today, but they add up over time. Spend decisions are great, that's why we work. It is important though that we consider the impact of our choices.
Spend $5 on coffee = get coffee, but lose everything that $5 could have purchased.
Save $5 = lose spending now, but gain everything that $5 could earn for future purchases.
Repay $5 - lose spending now, but gain all interest that $5 could save you for future purchases.
When we talked to consumers we often found they were repaying their debt by making extra payments each month, with the average being around $300 a month for those that were prepaying. They were often paying off their house and carrying credit card balances. This can be an emotional decision (hoping to be debt free sooner) or a logical decision (hoping to save money on interest over time). We found in our conversations that people wanted to be debt free, but they really believed they were saving a lot of money by repaying. They didn't understand the Tale of Two Tellers.
The LAG, or Liability Asset Gap, helps. If the credit card debt is at 16%, and the mortgage debt is at 5%, and the stock market over time is at 10% as a return. You use this to navigate and direct your choices. If I have $5 that I don't spend on coffee, I can earn 16% on that money right now repaying the credit card debt, or 5% repaying the mortgage debt, or 10% by saving for the long term as an investor.
$5 doesn't seem like a lot of money, but it is the concept that is key.
TIP: Train yourself over time to think about the gap in the decision you are making as similar to the two tellers, that there is something gained now but also something lost. Saving isn't saving, it's really just spending postponed. As a more advanced consideration, $5 you spend is actually about $6.25 earned. You have to earn $6.25 to have $5.00 after tax, so you are spending money that you worked to earn and what you spend is typically after tax. Money you have to repay debt, should be utilized to repay the highest interest rate debt first, but be careful when you repay debt that is financed at rates much lower than other savings opportunities.