Leveraging and personal finance

Dave Ramsey definitely caters to a particular audience. That is an audience that has little control over their spending and little, if any, financial intelligence. But I’d be very surprised if Ramsey has never encountered the term “leveraging“. I’m very sure he has. It’s a term that is very common in business finance, but the term applies to personal financing just as well.

In mechanics, levers are used to amplify force against a particular object. The action of a claw hammer prying a nail or a crowbar prying open a crate are common examples of levers. It allows a lesser force to be applied to a substantial mass.

In business, the amplification effect is with regard to revenue. In the sale of goods, revenue is directly proportional to inventory. To get more revenue, and thus more profit, you need more inventory. If you don’t have the cash on hand to buy that inventory directly, your only option is to finance it. Borrowing gives you the cash to purchase the inventory. When sold, this gives you the revenue to pay back the loan. What’s left over, minus any additional costs, is profit. And the profit that is left over will be significantly larger than what you otherwise would’ve had with a smaller inventory.

A ready example of this principle is “house flipping”. A flipper will borrow money to buy a house, spend additional money (borrowed or not) to fix it up, then sell the improved home. The revenue on the sale, minus any costs along with the loan, is the profit. Without the ability to borrow money to buy a home to flip, few would be able to do this.

With personal finances, the “inventory” is your time. We finance a lot of things. Credit cards are used to make purchases, and we take on loans to buy homes and cars. Homes give us places to live. This gives us shelter from the outdoors and a place to cook meals and store food, both of which save us significant amounts of time since we don’t have to seek shelter or find food. Cars give us the ability to get where we need to go significantly faster. Not even public transportation can match the time savings of having your own vehicle. Many (myself included) are even willing to swallow a higher cost of fuel for our personal vehicles to avoid the time cost of public transportation.

We finance purchases so we can acquire them now in the hope it will save us time later. We borrow now in hopes it will make our future ability to make money easier. You can be more flexible when you have a personal vehicle, which makes it easier to keep a job and find a better one since you’re not reliant on someone else to get where you need to go.

We finance large appliances for similar reason. Sure it’s a difficult to call financing entertainment centers a time saver. But what about the dishwasher and washer/dryer? Easily we can see the time saving value of these appliances, the “set it and forget it” feature that these provide that allow us to do other things with our time. It is a very powerful capability within our economy.

So let’s get to why I’m addressing Dave Ramsey. In an article called “9 Ways to Lose With Money This Year“, either Ramsey or one of his bloggers presents a list that includes this gem:

If you want to win with money, you need to take “payment plans” out of your vocabulary. Successful people don’t finance their couches. Or their dining room tables. Or even their cars. If you have to put it on a payment plan, you can’t afford it. As the old saying goes, “Broke people ask, ‘How much per month?’ and rich people ask, ‘How much?’”

Now one thing that needs to be pointed out again is Dave’s audience. His site does not write content for those of us who are financially stable, those of us who understand the tremendous power that comes with being able to finance purchases instead of trying to pay for everything in one lump sum.

At the same time, though, that doesn’t give him license to publish demonstrably false information.

One of the main tenets of building wealth is figuring out how to put someone else’s money to work for you. Whether it’s by borrowing or taking on investment capital, leveraging is part of getting rich. A rich man will ask both “How much?” and “How much per month?” depending on the situation. Recall from above where I said that borrowing now can save time and money in the future, depending on why you’re borrowing.

And how you “profit” from your leveraging activities is highly dependent on your aims. Typically instead of getting cash profit from leveraging, most people will instead profit by utility. For example, financing a car that can get you comfortably to work is leveraging debt that has the potential to secure future earnings by giving you a means of more reliably getting to work, which results in future earnings to eventually pay off the loan.

But all of this also requires planning. And that is a characteristic that is largely absent from Ramsey’s target audience. Unwise financing and borrowing is what got them into trouble, so Ramsey takes on the logical fallacy of all debt being bad, and that people need to financially neuter themselves and cut off all luxuries to get out of debt. Sure for some it works.

This doesn’t excuse outright lying to people, though. The rich do finance purchases in order to spread out the cost of what they are acquiring over time. Everyone finances in order to do that. The question that needs to be answered, truthfully, is what you are expecting to gain by doing that.