The Best Investment: Telling Debt to Buzz Off. Do You Agree?
Is debt the root of all evil or sunshine on a balmy day? It's funny how experts can be so divided on this issue. What do you think?
When you read a lot about investing (Zzzz... Hang on, it gets better!) a few patterns start to emerge before your very eyes.
Those who reach millionaire status do so because they:
- Understand delayed gratification.
- Live a frugal lifestyle (that often seems to involve sitting around in holey socks and a tiny supply of shirts).
- Go to college, but not necessarily an elite college.
You'll also commonly hear that millionaires often make their money on their own — they usually don't receive inheritances. Also, they aren't always necessarily raking in a huge salary.
And this one: They avoid debt.
Many experts disagree with the debt avoidance approach. They say that debt can be used as an investment tool and that it's a good thing for other reasons. Let's explore both sides of the coin: how eradicating debt makes the best investment and also examine how paying off debt might be incredibly short-sighted.
Why Paying Off Your Debt Makes the Best Investment
Let's go over three reasons why paying off your debt gives you the best all-around advantages.
Reason 1: You don't spend all your time trying to get out of a hole.
There's no question about it: When you're financially strapped, the struggle to get out of it can seem never-ending. Staying out of debt and watching your everyday expenses means you spend less time getting out of the financial doghouse.
Let's take credit card debt as an example. Say you can only make a $100 payment per month toward $5,000 of credit card debt. Let's also say your interest rate is 11% on that particular credit card. If you don't add a single dollar to that credit card balance and only make the minimum monthly payment, it'll take you 68 months to pay off your credit card — that's over five years! — and you'll also pay $1,719 in interest as well.
If you constantly find yourself in this trap, you might never claw your way out.
Reason 2: You free up your income to invest.
The money you put toward paying back debt sure could go toward better uses, such as investing it instead.
Let's say you plan to buy a car with a 5% annual percentage rate (APR). Instead of making $500 payments every month over the course of five years toward a car (which will depreciate), you invest your money instead.
An investment of $500 per month added to your initial investment of $100 would grow to a total return of $34,131 over the course of five years at a 5% rate of return.
In this case, the interest rate on your loan looks exactly like the rate of return on your investments, only backward. Keep in mind that it's satisfying to watch your investments grow and you feel just the opposite when you sink your money into paying off debt.
Reason 3: Less debt could mean an earlier retirement.
The U.S. Census Bureau's latest American Community Survey found that the average retirement age nationally is 64, and the average retirement age by state is as low as 61. In a few states, the majority of residents work past age 65.
The most basic reason for getting out of debt before you retire: You don't have as much disposable income, which means less money that you'll have to spend on the things you really want to enjoy in retirement — travel, hobbies, spoiling the grandkids and more.
Research shows that a reduction in mortgage debt since age 62 comes with lower bill-paying difficulty and lower levels of ongoing financial strain.
You can also find other unlimited reasons (while you're still in your working years or before retirement) why you might want to tell debt to catapult itself into oblivion: for peace of mind, less risk, better mental benefits (and even physical benefits!) and a stronger relationship with your spouse or partner.
Why Paying Off Debt Shouldn't Become Your Goal
Now, for every expert that suggests that everyone should get rid of debt, you can find another that parrots the differences between "good debt" and "bad debt."
Let's go over the reasons why it's okay to carry debt, and sometimes for a long time.
Reason 1: It could offer a financial payoff.
Good debt provides a financial payoff. For example, maybe you plan to borrow money from a lender to buy a bunch of rental properties. Maybe you get a student loan to go back to school so you can boost your career opportunities later.
This type varies widely from debt that doesn't offer financial benefits — paying on loans for cars, vacations and furniture, etc.
Some debt also has tax advantages. For example, you'll find distinct tax-deductible advantages for mortgage interest, interest paid on student loans, as well as money borrowed to buy investment property.
Reason 2: Avoiding debt can actually lead to financial problems.
Remember when your grandpa told you he built his home himself (without taking out a loan) and warned you about the evils of consumer debt?
Well, in this day and age, not taking on some debt might mean that you might not be able to buy a home or go to college. Going to college can bloom your financial advantages and buying a home can double or triple your net worth.
Reason 3: You can build a positive credit history.
Your credit history contributes to an overall good credit score, and to build a positive credit history, you must apply for credit.
Managing debt responsibly helps you build a good credit history. Your prospective boss might even check your credit history before you get a job!
How do you build a positive credit history? Only borrow what you can afford, use small amounts of the credit you have available (called credit utilization), pay your bills in full at every opportunity and make your payments on time.
Good vs. Bad: Where Does Debt Fall on the Spectrum for You?
Which "camp" do you fall into? The one where you pay off debt like a maniac? Or do you put major stock in debt that creates opportunities for you, especially if it's low cost and carries tax advantages?
Admittedly, you can say consumer debt can fall into a gray area. Debt doesn't go into an all-or-nothing scenario for many people, and many admit that it's hard to classify all debt as "good" or "bad." Certain types of debt may make no sense for some people but give others incredible advantages.
Is debt in the eye of the beholder?
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