There is one major prerequisite to becoming a successful real estate investor or entrepreneur that any aspiring person must master. That prerequisite is the deferral of gratification. Namely, to live below your means. This is step one of financial freedom.
Unfortunately, this is not something that has been embraced by most of the American population. As recently as 2006, Americans actually had a negative savings rate. And in 2014, the average household had a whopping $15,611 in credit card debt!
On the other hand, though, the most successful entrepreneurs are almost always frugal. As an article on Yahoo.com about the traits successful entrepreneurs share puts it,
“Amazon founder Jeff Bezos may believe that being frugal can help with innovation, but living a frugal life is championed by many other entrepreneurs and business leaders. For example, Warren Buffett, despite having the money to purchase anything he wants, lives a modest lifestyle. Instead of toys and mansions, Buffett’s riches come from loving what he does and doing it well. Facebook founder Mark Zuckerberg famously drove an entry-level Acura even though he was worth more than $7 billion.
“Being frugal doesn’t mean that you have to be cheap. It means not being careless with your money. Instead of taking loans out to purchase a luxury vehicle, save that money so that you can expand your business.”
This should not be surprising. High interest credit card debt chips away at your future wealth by forcing you to pay back money for things you’ve already used up. It’s anti-wealth. I’m not a huge fan of Rich Dad, Poor Dad, but Robert Kiyosaki’s advice to “pay yourself first” (i.e. to save) as well as to vividly see the difference between an asset (that which produces income) and a liability (that which consumes income) are key insights.
What this boils down to is what economists call time preference. An individual’s time preference is the relative value one places on a good now versus that same good at some later point in the future. The less time you’re willing to wait, the higher you time preference is. And the higher your time preference is, the more you’ll end up paying because of the interest that will accumulate during the time it takes to pay off the debt incurred to purchase that item.
Rent-to-own televisions, computers and furniture and even things like car loans are simply transfers of wealth from the impatient to the patient. This is all bad debt. Good debt, such as the mortgage on a rental home, allows you to leverage an income-producing asset and increase your income. This simple distinction is critical. Now, sometimes bad debt is necessary, such as with medical debts. But whenever possible, bad debts should be avoided.
Bad debt simply means you are obligating yourself to work in the future to pay off whatever you’re buying today. You’re demanding your future self to work to pay off whatever pleasure you are enjoying in the here and now.
Why make such obligations?
Why treat your future self so poorly?
Bad debt is the ultimate treadmill; it’s running to stand still. The work you do should pay for the present and build a nest egg for the future, not just allow yourself to pay off something you’ve already used up. Nothing better illustrates the importance of this than the famous Stanford Marshmallow Experiment.
The Marshmallow Experiment
In the experiment, young children were given a simple choice; eat one marshmallow now, or wait in a room alone with the marshmallow without eating it for 15 minutes and get two. The majority failed miserably and yielded to the temptation of the first marshmallow.
But a few succeeded. Most of them had to fight their sweet tooth tooth and nail to get by. But they somehow managed and got to indulge in two marshmallows after the long and torturous wait.
Many years later, the researchers followed up with the kids in the experiment. James Clear notes the results as follows:
“The children who were willing to delay gratification and waited to receive the second marshmallow ended up having higher SAT scores, lower levels of substance abuse, lower likelihood of obesity, better responses to stress, better social skills as reported by their parents, and generally better scores in a range of other life measures.”
Saving may feel like an impossible task sometimes. Too often, our lifestyles, materially speaking, act like water being poured into a jar; it takes the form of whatever jar it is poured into. So if we make $50,000 a year, that is the jar that our lifestyle will fill.
But if you make $50,000 a year, you can probably live on $40,000 a year. Maybe even $30,000. After all, most of us have lived off of less in the past. Excess savings is a key factor in being able to build a real estate investment career or even just a comfortable nest egg. Yes, there are ways to buy real estate without much money, but 1) having money makes real estate investment much easier, and 2) even if you make money in real estate without using much, you need to have the wherewithal to save it if you are ever going to reach financial freedom.
So break the jar and live below your means. The second marshmallow of financial freedom awaits.
What do YOU think is the most important factor in achieving financial freedom?