This article aged better than I had hoped. Yes in the days of cheap money, there was a (bad) argument against paying off debt. Today, that argument is a fallacy. Paying off debt is the only investment these days.
I have been attempting to raise my visibility on social media, lately. I have been commenting on Instagram and Twitter and I have ruffled a few feathers. Paying off debt is risky ?
The risk is losing possible growth through investing. To be specific, the argument made was:
“…disagree. This is why so many people are cash poor, they race to pay off debts costing them 3% with cash making 7-8%…”
Instagram rebuke of my comment about paying off debt (Instagram has financial advice?)
Firstly 3% debt rate is only for Mortgages (or secured credit). Most unsecured debt is much closer to 3 to 18% more than many advisers would have you think about. The “cash poor” phrase made me bristle, too. Remember how no one talks about house poor anymore.
Borrowing money to invest in the market always worries me. Leverage has the potential to make a lot of money, but it can also do the opposite. I wouldn’t do it, but I only buy Index Funds and similar ETFs.
A Scenario of What Can Go Wrong
I know a former exec at a large tech firm. He had many “options to buy” the firm’s stack at a lower price. He decided to exercise the options on the stock and hold the stock. Usually, the option is exercised and then a quick sell order is put in place to take profits from the sale.
This gentleman decided he would be cleverer, and hold the stock, to live off the dividends from it. The stock dividend yield was about 1% at the time, which would be plenty to live on. Money was borrowed to make the transaction, as it was for a large amount of stock.
Less than two years later, the dividends were reduced to zero. A short period afterwards, the stock was worthless. This was yet another firm that was “too big to fail”.
Is this a “corner case”, yes I think it is. It is also an excellent example of someone assuming, “the good days are here to stay”.
Removal of Debt, Addition of Options
If you pay off debt, you have more options. Do not fall for the FOMO (fear of missing out) arguments. If you have little or no debt, you then have options to do whatever you like, with your money.
Social Media and Financial Advice
Some frowned at financial talk on web sites. Then there was Twitter and Facebook that got in on it, but now Instagram and TikTok? Seriously, unless it is the Wizard of Omaha on TikTok, maybe get your financial advice elsewhere? Need I point at the Gamestop Reddit debacle to suggest maybe you should be careful where you get your advice?
A Very True Statement
“Think of borrowing money today as negotiating a pay cut with your future self”
Preet Banerjee
I really appreciate this post. I work in academia and when folks talk about debt it can be so complicated. For me, I just think ever less dollar of debt I have is one less claim on my future earnings.
I was agreeing with you BCM I hope you didn’t think otherwise. 😊
Never thought otherwise, and always appreciate feedback (mostly) :D.
From personal experience I prefer to pay off the debt/mortgage first. I was paying approx 14% mortgage plus child support back in 1991. I wanted that mortgage cleared ASAP. The money you have after you can invest if you so wish. So i am all for the sure bet – pay the mortgage off and you are more assured of having a roof over your head if things go sour for any reason.
Wonder how many people have lost their employment but wanted that investment opportunity they saw in GME & AMC
I run a HELOC for investment purposes. So my interest expenses are claimed against the dividends and the left over goes to pay down the principal. I was still lucky. Two of my holdings cut dividends but there is still enough to go towards debt reduction without me contributing. Luckily the bank rate also dropped at the same time.
RICARDO
The type of person who replies to you on social media as per your quote is quite likely not your average family but is far more engaged or someone who sells investments. Joe Averages mortgage is still at 3.5 % or more (because no one told him/ her rates dropped they should call up their bank for a new rate) they pay it from after tax income so it costs interest rate plus your marginal tax rate. If you advertised a guaranteed rate of return 4% to 5% you would have line up round the block. Most Canadians are in closet indexing underperforming active funds with MER or F class plus advisors fees of 2.5% so assuming 7% the actual after fees is 4.5% and tax comes off that and will be paid sometime unless its a TFSA. Sound bites that person throw out are unhelpful without looking at the persons big picture. Roof over your head in a pandemic, sickness, job loss is priceless. Been there done that got the Tshirt I know how it feels. (the consolation is there is so much garbage said on social media no probably read it anyway)
I think I represent that remark, but I understand the sentiment.
Everyone has a different story, and folks need to keep that one in mind. I talk to my (grown) children and give advice, but also tell them that they need to figure out what works best for them. Read Doug Hoyes book to find out how folks who had a good plan or were on an even financial keel, end up in financial hell quickly. I view debt as a very bad thing, but some folks can stand the risk (I have been told, I never met them though).