From the Expert: Avoid these debt traps

November 7, 2007

Debt's not all bad?and the truth is, it's inevitable. The problem is how you manage your debt. Good debt includes buying a house, financing a car, or paying for a college education. Bad debt is when you borrow to support poor spending habits. When banks stand in line to loan you money, it's not hard to get sucked into using credit cards to pay for lavish lifestyles and exotic vacations. Sometimes, though, "keeping up with the Joneses" becomes a lethal addiction. Before you know it, you're left with little or nothing to stash away.

Debt's not all bad…and the truth is, it's inevitable. The problem is how you manage your debt. Good debt includes buying a house, financing a car, or paying for a college education. Bad debt is when you borrow to support poor spending habits. When banks stand in line to loan you money, it's not hard to get sucked into using credit cards to pay for lavish lifestyles and exotic vacations. Sometimes, though, "keeping up with the Joneses" becomes a lethal addiction. Before you know it, you're left with little or nothing to stash away.

What can you do to avoid the perils of bad debt? First, live within your means. It's a basic concept, but many doctors find it challenging. After being financially deprived during medical school and residency, new physicians sometimes spend freely on what they can't afford. They figure they'll eventually make enough to pay for that big-screen high-def TV, hot new sports car, and vacation home. But being guilty of an affordable indulgence or two is different from having uncontrollable spending habits, whether you're a new physician or well-established in your career. If you say, "But, I deserve it," over and over, you'll quickly send yourself to the poor house. Certainly, it's not just physicians who are guilty of this behavior: Americans on the whole are suffering from the repercussions of spending for instant gratification.

If you realize that you're accumulating too much debt, don't try to bail yourself out by taking a loan (if allowed) from your retirement plan. Not only will you lose out on future earnings, you'll have to pay interest on your own money. The amount you take out won't benefit from the magic of compounding. And you'll be putting it back in your account with after-tax dollars.

Avoid taking a margin loan against any taxable investments you own. A margin loan allows you to borrow from your broker, using your investments as collateral to purchase additional securities. It's also a bad idea because of the high costs and risks involved. You'll likely need a hefty return on your investments just to break even. In addition, if those investments decline in value, you've really dug yourself a hole.

And don't use a home equity line of credit (HELOC) indiscriminately. HELOCs are best used for short-term home improvement projects, not for financing additional debt or unnecessary purchases. HELOCs usually come with variable interest rates. The increased risk from those rates combined with using your home as collateral makes this a dangerous game.

Steer clear of credit card temptations. Don't keep multiple lines of credit open; use one low-rate card for all your daily and emergency spending needs and pay off the balance each month. Set concrete spending limits and don't accept extravagant increases in your line of credit. A reasonable credit limit will stop you from purchasing big-ticket items you don't need. Remember that credit card companies market to affluent professionals like doctors to entice you to charge more, more often.

Lastly, learn how to say No! Be able to identify the difference between a want and a need. Set limits for yourself and, if necessary, for your spouse and kids. As a physician, you spend your career helping people get well. Help yourself and those who depend on you to stay fiscally fit too.

The author is a fee-only certified financial planner (CFP) with William Howard & Co. Financial Advisors (www.whcfa.com) in Memphis. His firm provides comprehensive fee-only financial planning and investment services to high income and/or high net-worth individuals. The views expressed are those of the individual contributor and do not necessarily reflect those of Medical Economics magazine.

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