Consumer debt: why it's a trap for your assets
Productive debt vs. consumer debt
Some debts can be beneficial if they are well managed, such as a mortgage for a primary residence or a loan to start a business.
However, there is another category of debt that is much more problematic and harmful: consumer debt.
In my opinion, Consumer debt is one of the biggest obstacles to financial freedom !
In this article, we'll look at consumer debt: why it's a trap for your assets.
- Why consumer debt can hinder your wealth accumulation
- how people get into debt very easily
- What are the economic consequences of these choices?
Statistics concerning debt
According to the newspaper Econostrum, approximately 151% of Swiss households are experiencing payment delays due to economic difficulties. Paradoxically, an increasing number of families are accumulating consumer debt.1
In France, there are approximately 10 million people in debt. Around 60% of these debts are consumer debts.
What is consumer debt?
Consumer debt is a loan taken out to buy a good or service that loses value quickly or is consumed immediately.
For example :
- Buying a smartphone on credit
- Finance a vacation with a loan
- Using a credit card without paying off the balance
- Financing a car that's too expensive for your budget
- Use "buy now, pay later" services«
👉 Unlike an investment, these expenses generally do not generate any future income.
You are spending money today that you haven't yet earned. And worse still, you are going into debt for something that will bring you no benefit later.
Why is debt a problem for a frugal person?
Frugalism mainly consists of increasing the gap between one's income and expenses in order to save and invest more.
Debt produces exactly the opposite effect!
- Each monthly payment reduces your available savings.
- Every interest payment enriches the bank rather than your assets.
Instead of moving towards financial freedom, you're going backwards! Because in truth:
👉 A frugal person seeks to put their money to work.
👉 Consumer debt forces your future salary to work to repay past purchases.
It's like putting a ball down a slope... and hoping the ball rolls uphill 🤔
The psychological effect of debt
One of the less visible dangers of debt is its psychological impact.
When a person has multiple loans, they may experience:
- Stress
- Anxiety
- A loss of control over his finances
- A dependency on monthly salary
Unfortunately, some people no longer work to achieve their goals. They work only to pay off their debts. 😐.
This situation can become extremely burdensome over several years.
The most frequent examples of debt
The smartphone on credit
A phone costing 1,200 CHF seems cheaper when you're offered to pay only 50 CHF per month.
However, the price to pay remains the same (in truth, it is even more expensive because of the interest).
The monthly payment option simply gives the impression that the purchase is more affordable. But in reality, it remains a very expensive expense for the customer.
It's a widely used marketing technique.
The car was too expensive
The car is probably one of the biggest destroyers of heritage 😐.
Many people choose their vehicle based on the monthly payment rather than the total price.
For example :
- Car loan: CHF 500 per month
- Duration: 5 years
This represents a total of 30,000 CHF.
During these 5 years, these 500 CHF cannot be saved or invested.
Holidays financed by a loan
Holidays create wonderful memories.
But paying them back over several years is much less pleasant.
When memories fade but monthly payments remain, pleasure diminishes rapidly.
Credit cards
Credit cards are affordable when they are paid off monthly.
On the other hand, when a balance is carried forward, interest rates can become extremely high.
Some people end up paying several times the value of their initial purchases because of interest.
The hidden cost of debt
Most people only look at the interest rates. But the real cost is often elsewhere.
Let's take a simple example.
You borrow 5,000 CHF to buy consumer goods. Consequently, this 5,000 CHF is not invested.
Let's assume they had generated 7 % per year on the stock market for 20 years.
In the end, The 5,000 CHF could have become approximately 19,000 CHF.
Here is a table to help you understand:
| Situation after 20 years | Person A: Invests CHF 5,000 | Person B: Spends CHF 5,000 on credit |
|---|---|---|
| Initial amount | 5,000 CHF | 5,000 CHF |
| Use of money | Stock market investment | Purchase of a consumer good with debt |
| Average annual yield | 7 % per year | 0 % |
| Value after 20 years | ≈ 19,000 CHF | 0 CHF |
| Interest paid | 0 CHF | – 500 CHF |
| Loss of property value | / | – 5,000 CHF |
| Final assets generated | +19,000 CHF | 0 CHF |
| Wealth gap between the two people | – 19,500 CHF |
👉 The real cost is therefore not just the debt. It's also the lack of investment!
Why do banks like consumer debt?
The answer is simple. Because they are… profitable.
The more a person borrows:
- The more interest she pays
- The more fees she pays
- The more it depends on the banking system
- The more pressure the bank can put on the customer
This doesn't mean that banks are bad. But in reality, their economic interests are not always aligned with those of the customer.
- Your goal is to accumulate wealth.
- Their goal is to sell financial services.
The objectives are not the same.
How to avoid consumer debt?
Here are a few simple rules:
Wait before buying
When you want to buy something important, wait a few days.
Very often, the desire disappears.
Save before you consume
Instead of buying on credit, it builds up a cash reserve.
Then, buy with cash.
Avoid monthly payments
When a seller insists on monthly payments rather than the total price, that should raise a red flag.
Always analyze the overall cost.
Build an emergency fund
A financial reserve prevents you from having to borrow money in the event of an unexpected expense.
Are all debts bad?
No. Some debts can be useful.
For example :
- A reasonable mortgage
- A loan to develop a profitable business
However, even in these cases, the risks and reimbursement possibilities must be analyzed.
A debt is always a financial obligation and a considerable burden on your budget.
Conclusion
In my opinion, Consumer debt is one of the biggest enemies of financial freedom.
She:
- reduces the ability to save
- reduces investment opportunities
- can generate stress for several years
A frugal person seeks to accumulate income-generating assets. However, consumer debt does the exact opposite: It transforms future income into repayments.
👉 Every time you avoid unnecessary debt, you take a step towards financial freedom!
👉 Every time you buy with cash using your savings, you strengthen your wealth.
In conclusion, if you currently have consumer debt, pay it off as quickly as possible. And above all, avoid taking on new debt that will only make you poorer.
Sometimes, the simplest way to get rich is simply not to spend unnecessarily.
FAQ: Consumer debt: why it's a trap for your assets
What is consumer debt?
Consumer debt is a loan used to finance a good or service that quickly loses value or is consumed immediately. For example: a smartphone on credit, a vacation financed by a loan, or a car that is too expensive for one's budget.
Why are consumer debts dangerous?
Consumer debt reduces the ability to save, increases monthly expenses, and often prevents people from investing their money. It can also generate financial stress and slow the path to financial freedom.
What is the difference between productive debt and consumption debt?
Productive debt can be used to create or increase wealth, such as a reasonable mortgage or a loan to develop a profitable business. Conversely, consumer debt generally finances assets that lose value and generate no income.
Why can monthly payments be misleading?
Monthly payments give the impression that a purchase is affordable. However, they often mask the total cost of the loan. A car at CHF 500 per month for 5 years, for example, represents a total expense of CHF 30,000.
How can credit cards become a problem?
A credit card is convenient when it's paid off in full each month. However, when the balance is carried over, the interest can become very high and significantly increase the actual cost of purchases.
What is the hidden cost of consumer debt?
The hidden cost is often the lack of investment. For example, CHF 5,000 invested annually in 7% for 20 years could reach approximately CHF 19,000. Using this money for consumption means foregoing this potential growth.
Why can cars financed on credit harm one's assets?
A car typically loses value every year. In addition to loan interest, the owner suffers from the vehicle's depreciation while tying up a significant portion of their monthly budget.
How to avoid consumer debt?
To avoid consumer debt, it is advisable to save before buying, to build up an emergency fund, to avoid staggered payments and to wait a few days before major purchases in order to limit impulsive purchases.
Do consumer debts prevent one from becoming financially free?
They can significantly slow down the process. Each monthly payment reduces the amount available for saving and investing. In the long term, this diminishes the ability to build wealth and achieve financial independence.
Should you pay off consumer debt before investing?
In most cases, yes. The interest rates on consumer debt are often higher than the guaranteed return you can get with savings. Paying off these debts quickly generally improves your financial situation.
Consumer debt: why it's a trap for your assets
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Consumer debt: why it's a trap for your assets
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