If you lived like the filthy rich, you could buy your yacht and your luxury vacation home at the beach with cold, hard cash. But, you probably wouldn't.
That's the surprising finding recently reported by The Wall Street Journal, which looked at debt among the truly upper crusty -- the richest 1%, or those whose net worth measured at least $6 million.
If you can believe it, these households (whom reporter Robert Frank termed the "leveraged elite") have been piling on the debt even faster than us regular, middle-class types. According to the Federal Reserve Board's Surveys of Consumer Finance, the richest 1% accumulated $342 billion in new debt between 1998 and 2004.
As of that date, the richest 1% now held 7% of the nation's total debt, and economists expect that the share might have grown since then.
If you suspect that the wealthy don't live like the rest of us, you may not be too surprised to learn that in some ways they don't borrow like the rest of us. In other ways, they're just as prone to fall into debt's many traps. Here's what you can learn from the way the other half borrows.
Think strategically. The rich use debt as a financial tool, choosing to purchase their vacation home in Italy with a mortgage if their money can be invested more profitably elsewhere. In this way, the rich have much more flexibility than many people. The very existence of 30-year mortgages shows how few of us can buy a home with cash or gold-embossed check.
But you can think about whether your smaller debts represent the most profitable use of your money. If you consider the long-term cost of car loans and credit card debt, among other types of consumer financing, you may quickly realize that you'd be better off investing that extra money, instead of paying interest to the bank. Try to save for large purchases to minimize your unnecessary debt and put more of your money to work for you.
If you're thinking about taking on new debt for something that's not an essential expense -- whether it be a jet or a pile of new sweaters -- ask yourself whether there is an economic justification for financing the purchase. (If you're using a high-interest credit card and not paying the balance, the answer is automatically no.) Then ask yourself whether you can immediately pay the debt should something unexpected happen or an emergency occur. In the best case scenario, you could get rid of that debt quickly if necessary.
Keep an eye on the big picture. According to the Fed's statistics, debt held by the richest 1% amounted to only 3.7% of their total wealth. How does your debt compare to your wealth? If you're an average, middle-class household, it's probably closer to 24%.
Knowing your approximate level of debt can help you make decisions about whether a major purchase financed by debt is good for your overall wealth. It can also help you put any bank recommendation in perspective -- they may be willing to lend you a lot more than you may think prudent to borrow. Of course, keeping your debt low when compared with your wealth also indicates you're keeping a good measure of flexibility in your finances by earmarking fewer dollars to debt service. The lower your debt levels, the more you can put your money into more profitable investments.
Ignore the Rockefellers (and the Joneses). Being rich apparently does not make you immune from the pressure to have all the same stuff as your neighbors, whether you can afford it or not. (You might enjoy a little bit of schadenfreude in knowing that prices for luxury goods have been going up faster than inflation.) As a result, the merely rich have been borrowing more and more in order to keep up with the excessively rich and the obscenely rich. It seems that being a single-digit millionaire just doesn't buy you that much cache anymore.
If the multimillionaires still feel they have to overspend to keep up with the ultramillionaires, then this debt trap knows no income bounds. Forget the Joneses. Resist the impulse to buy more than you can afford. Reinforce the lesson that it's futile to try to keep up with the neighbors by calculating what your extra consumer debt costs you. What happens when you catch up? You'll just be striving to keep up with the Rockefellers.
Related Foolishness:
For personal finance planning of all kinds, try a free 30-day trial to Motley Fool Green Light.
Fool contributor Mary Dalrymple will have to buy her yacht and vacation home with Monopoly money. She welcomes your feedback. The Motley Fool has a disclosure policy.
