Overextending Your Way to Wealth
Posted by admin in General
Growing up I always thought it was bad to be "overextended." I remember my parents saying of a neighbor, "he's overextended," meaning that the neighbor had bought so many "things" that he couldn't afford to do anything anymore. For instance, he had a boat sitting in his yard for years because he didn't have the cash to actually put it on the water. No one wants to live that way.
But these days I have a different outlook about being overextended, mostly because I define the word differently now.
Overextended can certainly mean that you're trapped by debt, or that you have no cash flow because you put all of your money in assets such as clothes, cars, etc. that only depreciate over time.
On the other hand, overextend can also mean pushing at your comfort zone in the short term for longer-term gains. It can mean tieing up more of your money in assets, but tieing it up in appreciating assets, and making doable short-term sacrifices.
The easiest example is real estate. My wife and I have owned three homes. With each one, we made a decision to stretch our comfort zone. In two of the homes, we bought more than we could easily afford. Not more than we could afford, but more than we could "easily" afford. We knew going in to each one that our mortgage payments would be sizable for our income levels, but we loved the homes and knew they'd be good investments. Besides, we were (and maybe still are) on the correct side of the earning curve, so we assumed our income would keep rising and we'd get some more breathing room over time.
What's the worst that could've happened? Well, one of us could have lost our jobs, or gotten sick, or had some other event that suddenly made our mortgage too big of a burden. We thought about that long and hard and finally said, so what? We could buy a house that was completely affordable and have a ton of cash flow and still have something horrible happen that would make the payments unbearable. In the end, the risk wasn't nearly as big as it at first seemed. And it's no fun to constantly live as if tragedy is around the corner.
So we went for it. And it worked out fine each time. We built equity much more quickly, which gave us more options when we bought our next house, and that situation replayed itself when we bought our third house. (Although this time, a little older and with kids, we didn't strain ourselves with a bigger mortgage due to a bigger house, but instead bought a more affordable home and cut our mortgage term back to 20 years. It's still a bit of a strain, but God willing we'll live to see this house completely paid off.)
Another thing about "good" overextension—it stops you from spending money frivolously. It's not always fun to have less cash flow, but it forces you to think about the things that are most important to purchase, and it makes the occasional treats more special. Give yourself a bigger cushion and it becomes easier to throw that money around on pleasures that are much more fleeting. You may find yourself looking back in 10 years and wondering how you made so much money and have so little to show for it.
Other good overextensions? Maximizing your 401(k) even though it cuts into your take-home pay comes quickly to mind.
There are other ways to overextend in order to invest, but I can't think of any that I could justify to myself. You really need to be sinking your money into sure things, or at least as close to sure things as you can get. Outside of real estate and retirement savings, it seems you get into areas that are too speculative to justify sacrificing your short-term cash.
Have you ever overextended for the right reasons?
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