What is the quickest way to pay off debt?

snowballThe common answer is to arrange the debt that you owe either by size (popularised by Dave Ramsey as the Debt Snowball) or by interest rate (see Debt Avalanche Definition | Investopedia).

But, both of these methods are flawed because they incorrectly assume all debt is bad (see Good Debt Vs. Bad Debt), but this is only true before you take on debt.

But, once you have taken on debt, debt is either cheap or expensive and requires a whole new way of thinking …

There’s an old adage that says a penny saved is a penny earned.

Well, this is also true for debt, where the currency is not pennies, but interest rates:

A percent saved in interest is exactly the same as a penny earned in interest.

This means that you should sort all of your debts and all of the possible ways that you could earn interest on your money in order of interest saved or earned.

It would work something like this example:

I still owe $1,487 on my credit card at 19% interest

I still owe $5,352 on my auto loan at 11% interest

I can invest my money in a low cost stock Index Fund and earn 8% return

I still owe $142,694 on my home loan at 5% interest

I still owe $11,223 on my student loan at 2% interest

I can invest my money in a CD and earn 1% interest

Notice how this list is sorted by amount of interest paid or interest (return) earned?

So, if you would have cash left over each month after making the minimum payment on each of the loans, instead of simply keeping it in the bank (earning 0% to 1%) as most people would do, this table makes it very easy to …

Pay off your expensive debts quickly and safely earn a much higher return on your investments:

Step 1: Instead of making the minimum payment on your credit card, make the minimum payments on your auto loan, your home loan, and your student loan, then

Step 2: Pay as much as you can then spare that month on your credit card. Repeat monthly until paid off.

Step 3: Once the credit card is paid off, move to the next on the list (i.e. your auto loan). Notice how you should have much more available to pay monthly, as you no longer have to make any payments on your credit card – which was your most expensive debt, at 19% interest!

Step 4: Once the credit card and auto loans are paid off, stop paying down debt (this is where the Debt Snowball and Debt Avalanche & all other ‘pay off all debt’ strategies fail), instead:

Step 5: Continue to make the minimum payments on your low interest home loan and student loan, and pay as much as you can spare each month (which should be quite a lot, now, as your most expensive loans are now paid off!) into an investment such as a low-cost stock Index Fund. This is Dollar cost averaging into the whole US stock market, and is Warren Buffett’s preferred strategy for non-experts to invest (source: Warren Buffett to Heirs: Just Use Index Funds).

Step 6: Revisit this list every 6 to 12 months (simply resorting your debts owed and invest opportunities into strict interest-rate (paid or earned) order, and follow the steps, starting at the top and working your way to the bottom.

Note: If any of your loans has a term (i.e. has to be paid off by a certain date) and your minimum payments are not sufficient to pay them off in time, simply withdraw some of your Index Fund balance a few days before the loan falls due and pay it off. Then, resort your list and start again.

You will thank me when it comes time to retire …

{Also published on Quora: https://www.quora.com/What-is-the-quickest-way-to-pay-off-debt}

Debt free or financially free?

A recently-graduated student asks:

What would be a better investment than paying off $30K of subsidized low-interest student loans?

Money available: 30k
Interest on subsidized student loans: 3-4%
Principle: 30k

Do I pay them off, or look for a better investment, and keep the spread? What would be a better investment?

If you’re also trying to decide whether you should pay off debt or start investing, here’s what you need to decide right now:

Do you want to live debt free or do you want to live financially free?

If you choose the former (debt free), you may make some GREAT investments: eg paying off your 19% credit cards (probably the best investment you will ever make in your life; avoiding this kind of debt will be your second best investment).

But, if you blindly pay off ALL of your debt, you will also make some TERRIBLE investments: eg paying off your student loans will only ‘return’ 3% – 4%.

So, let’s list all of the debt (and their interest rates) that you may have on one sheet of paper, and all of the investments that you may like to make – with their likely (historical) returns – on another.

Now, on a third sheet of paper, put the items from BOTH other lists into one new list, strictly in descending order of interest rate and/or return.

THAT’S where you should allocate your money … from the top down.

Here’s a practical example for you:

Your current student loans are costing you 3% – 4%, and I presume you have no other debt (or, I assume you would have mentioned it).

The Dow Jones (i.e. the top end of the US stock market) has NEVER had a 30 year period where it has returned less than 8%.

So, provided that you are in this for the long term …

Put your money into a low-cost index fund, until you learn the skills to reliably invest at even greater long-term returns than 8%.

What do you do with the student loans? Pay them down slowly (safest) or let them sit until you have to pay them off (more risky).

Now, that’s how to start the process of becoming financially free.

Avoid dead money …

Welcome PT Money and Dinks Finance readers!

Here is my guest post at Dinks Finance: http://www.dinksfinance.com/2012/11/why-1-million-will-never-be-enough/ and PT Money: http://ptmoney.com/not-all-debt-is-bad/

Now, back to today’s post, which is about Emergency Funds (and, why you should NOT have one) …


To me emergency funds are dead money …

This is a controversial idea, so I get a lot of flack every time that I share my thoughts on this … but, I also get some agreement from readers like Milton:

A number of responses to your guest post seemed to misunderstand what you were saying about emergency funds. Your standard PF emergency fund is cash that is sitting in a bank account and earning a microscopic return that is being outpaced by inflation.

Some people … are sinking in debt, paying 18-25% on debt while their emergency fund earns less than 1%. It’s as if they don’t understand that those high-interest debts ARE THE EMERGENCY.

It seems idiotic, as Milton points out, to pay 18% on a $2,000 (say) credit card balance when you may have $10k cash ’emergency fund’ sitting in a CD (earning just 1.05%).

And, if you agree with that …

… then, why is it such a leap to realize that instead of even trying to build up an emergency fund of $10k (so that you can earn 1%) you should be trying to build up an investment fund (so that you can earn 8%+)?

But, that’s not the only ‘dead money’ that you need to mop up:


If you agree that earning 8% is better than earning 1%, why would you try and pay off your 1% student loan instead of investing that money at 8%?

Hmmm …

Now, that suddenly opens up a whole new way of thinking about debt, doesn’t it?


How to pay off credit card debt?

Last week, I asked our readers what advice they would give to Chris, who asked for help getting out of credit card debt:

Over the past 2 years I have watched as my credit card debt has risen to over 13K. I  have a very well-paying job, making 130K

The vote is in and, as the graph shows, just over one quarter of our readers thought that Chris should just continue paying off his existing cards.

But, why pay at 13% interest, when you can pay the same debt at 0%?

And, if it takes you one year to pay off the 13% debt, say, then you should be able to pay it off in just 10.5 months at 0%, so why pay more/longer than necessary?

Fortunately, just over half of you thought that Chris should transfer his debt to a 0% APR card. I like this strategy … as I said last time, a dollar saved is exactly the same as a dollar earned.

This means that Chris has just earned 13% after tax interest, simply by moving the debt to a 0% card!

Of course, that doesn’t mean that you should now go out and rack up a whole lot of expensive c/card debt just so that you can move it to a low – or zero – interest credit card 😉

Whilst a good first move, another reader (whose name is also Chris) pointed out that just moving credit card debt from one card to another is not really a debt reduction strategy; you also need to figure out how to pay the card off before the 0% interest period expires.

Even more than that, this reader advises:

Not only do you need to pay them off ASAP. You need to cut them up so you don’t rack up debt for a third time…No one should be putting a honeymoon (aka vacation) on a credit card without a clear plan to pay it off.

The other option that Chris offered was to pay off his credit card debt by borrowing against his 401k; Chris says that he can borrow the money effectively at 0% and pay it back at his leisure (the ‘loan’ is at 4% interest, but that is actually credited back to his own 401k).

But, another reader, Steve, pointed out one potential flaw in this strategy:

He needs to weigh against what he could earn (inside his 40k) against what he saves from paying off this debt, and what he puts back in. If he is paying himself 4% interest into this 401k program,but could earn 7% by not taking it out, [it] seems like a bad idea.

I don’t think it matters greatly which option Chris takes as long as he:

a) eliminates the 13% APR debt immediately (either by moving it to a new 0% card, or borrowing other 0% funds to pay it off)

b) has a plan to pay off the outstanding (now 0%) debt off as quickly as possible

c) has a plan to stop the debt from re-accumulating once paid off

The bottom line: if you find yourself in a situation like Chris, follow the 2-Step Wealth Creation Strategy that I outlined in a recent post and you won’t go too far wrong in your own financial life 🙂


Help a reader pay off their credit card debt …

What should this reader do?

View Results

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Help a reader out by reading this, then answering the poll:

When I first spoke to you, I had just paid of my cc debts and was working 2 jobs and saving a little money.  4 years later, and I have since moved from NYC to Miami, got married, just had a baby, and right now I am in the process of buying our first home. (Not an investment, but our primary residence.)

With all of the life changes that have happened, my savings is gone (we had to pay for the move, marriage, and honeymoon ourselves) and over the past 2 years I have watched as my credit card debt has risen to over 13K. I  have a very well-paying job, making 130K in Miami as a computer programmer, but right now I am the only source of income, as my wife is not working.

Anyway that is a quick catch-up with my life to date. And I have question for you.

Once I close on my house, my next move is to get rid of cc debt. Here are the 3 choices I see available to me. (Perhaps there are other ways, I am just not aware)

A. Pay it down heavily and hope to pay it off over 2 years.
B. Move it over to a 0% card for 15/18 months.
C. Take a loan out against my 401K to pay it off credit card immediately

Chris also wanted me to know that the “loan against my 401k is special in that the 4% interest I pay back is added back into my 401K account. So every penny I pay goes back to my pocket. There is no hit to my credit, since I am borrowing against my own funds, and it allows me to pay back less aggressively.”

What would you do? Please help me help Chris by choosing one option from the poll …

Note: if you chose ‘other’ please leave a comment; if you didn’t choose ‘other’, please still leave a comment 😉

PF advice in America is broken …

Thanks for the great – and, well thought out – responses to Bristol’s shout out for help with his debts:

I was stuck in an internal conflict about paying off debt or investing for years until now. I would like to apply your debt cascade to my financial situation and need your help.

You’ll have to take a quick look at my original post for the details, but the jury was pretty much split over whether Bristol could (or should) pay off his debts now or later (for the purposes of investing instead).

Marie summarized the ‘FOR paying off the debt fast’ case quite succinctly:

Seems like he can pay off his loans in 19 months

But, many were on the AGAINST side, including traineeinvestor who offered some great advice:

I would invest it all and not make any early debt repayments. Five percent (the most expensive debt – assuming it is not tax deductable) is a pretty low threshold rate of return to beat and mortgages and student loans are unlikely to be called early unless you miss a payment.


I’m right on the fence with this one … for two reasons:

The first is that, while average returns are much better than the interest rates being earned (actually saved … but a dollar saved is a dollar earned right?), if Bristol also applies his $10k cash stash to the debt, it may take him <2 years to pay off all of the loans … over that short period who knows what investment returns will be?

And, there is something to be said for being debt free … especially when it can happen so quickly!

[AJC: on the proviso that the debt repayments are immediately rolled into an aggressive – and, maintained – investment program]

On the other hand, if Bristol has a plan to make an immediate investment (found a great business to buy or invest in; found a great real-estate investment; has a brilliant idea for anew business; and so on) then why hold off on ‘the big payoff’ to pay down circa 5% debt, instead?

But, Bristol has none of those plans right now, and that brings me to my second – much more important – point, foreshadowed by Luis:

Who cares about your debt at this time! What do you want to do with your life?

Bristol’s current life plan – not what to do with his debt – is the problem … because his current life plan is impossible!

Here’s what Bristol shared:

I do have a stable job where I invest in the 401k up to the match% only. I have $10000 in a savings [account] and $10000 in a few blue chip stocks. I would  be willing to invest the majority of my savings. I am currently 23years old and would like to retire at least by age 55. So that would be 2066 and per cnn retirement calculator i would need 5.9million dollars (2.2million in todays dollars) to spend retirement happily. I think i could reasonably get 8% return. I think I would mostly like to invest in the stock market.

I think the expectation of working hard, living sensibly, saving hard, and starting young to retire on $2.2 million dollars (today’s dollars) in 30+ years would seem reasonable, wouldn’t it? In fact, this seems to be the mantra of much personal finance advice right now …

Yet, this is what happened when I sent Bristol off to play with an online calculator for a while:

I have been plugging my numbers into a similar calculator one that takes into consideration additional monthy contributions and have realized that if I want to reach my goal I will have to be much more aggresive. Although it is possible for me to get there, its just not happening on 8%. So I have alot of thinking to do about how to get there and how much risk Im willing to take. One thing is for sure, time is money and I will not be putting extra money onto the school loans anymore!

Inflation forces very large Numbers for even relatively modest retirements:  <$90k p.a. in today’s dollars (Bristol’s approx. target, based on a 4% ‘safe’ withdrawal rate on his $2.2 mill. pre-inflation target) may be considered luxurious by many, but – be honest – would you be happy working hard and being financially disciplined for 30 years and retiring on less?

So, inflated (at a relatively modest 3% inflation rate) an ‘easy’ target like $90k a year (today’s dollars) requires you to save nearly $6 million over your working life; simple logic tells you that this is impossible for a normal working person … Bristol included.

Bristol’s problem isn’t how to pay his debt; it’s how to amass at least $6 million in 30 years!

And, Bristol’s not the only one …

Personal finance in America is broken; the advice is small picture (pay debt, live frugally).

Who’s there to give the Bristol’s of this world the big picture?

Help a reader …

I received this e-mail from Bristol:

I am in love with your debt cascade idea, I was stuck in an internal conflict about paying off debt or investing for years until now. I would like to apply your debt cascade to my financial situation and need your help.

I have an extra $2000.00 after minimum payments per month that I dont know what to do with.

StudentLoan $15000 @ %4.25
StudentLoan $15000 @ %3.75
StudentLoan $8000 @ %3.5
Mortgage $130000 @ %5

What amount would you put on these loans and what amount would you invest?

Help me help a reader; what advice would you give?

The False War On Debt …

There’s a war raging out there: it’s being fought by authors and bloggers everywhere.

But, is it the right war? Is it a just war? Or, are we just throwing ourselves, by the millions, into a hail of fire: exploding spending, rampant inflation, the death of social security?

Sure, as we sit in the relative safety of our trenches (at least, that’s what we tell ourselves, until a random mortar shell of job loss or unexpected expenses chooses to lob our way) this is not OUR future … it’s somebody else’s, or it’s too far away, or it just can’t happen …

The sad truth is that legions have jumped the wall before us and have been brutally cut down for lack of an adequate nest-egg; it’s sad to see them go over the dreaded wall of retirement (be it their time, or forced on them early) without an adequate safety net … when they do, it’s as though their grim fate had already been sealed.

Broke – or ‘just’ financially crippled – and unable (for financial reasons) to live life as they had hoped, they are a sad, sad lot.

You see, the war that they fought wasn’t – isn’t – a just war. It’s not even a war … well, it shouldn’t even be more than a skirmish.

It’s the War Against Debt!

When it comes to that war, I’m strictly a pacifist; isn’t it better to simply avoid BAD debt?

Of course, that doesn’t mean that we can’t … shouldn’t … defend ourselves.

Far from it: if we find that BAD debt has snuck through our defences, let’s keep an eye on it. And, if we find that it’s also EXPENSIVE debt, then let’s whip out the Big Guns and wipe it out. Quickly, surgically …

… but, let’s not commit Debt Genocide.

You see, unlike the well-intentioned, but largely Debt-McArthyist “ALL Debt Is Bad, So Let’s Wipe It Out” rabble out there, let’s first ask The Missing Question:

What will you do after your debt is paid off?

“Well, start investing of course!”

But, does that REALLY happen? Who better to ask than Money Reasons:

This past February 2010, I became totally debt free, but now what!

I thought that there would be a period where I would break even for a while, and then start to plow about $1,000 extra each month into investments!  So now that it’s seven months later and how much extra did I save or invest?  Not a single cent!

Hang on, the whole purpose of suiting up for battle – for going to war against debt – was so that you could start investing, right? What’s up with that, Money Reasons:

Well it’s been a matter of bad luck with equipment breaking down and needing replaced and spending too much for our past vacation to Hilton Head Island!

But it’s also been a subtle form of LifeStyle Inflation!  Thinking back now, I realize that when wants would arise, I would just go ahead and buy it.  Yeah, I thought about it a bit, but I knew that I had the cash.  Then when your car and lawn mower broke down, I had the cash too…

Money Reasons should have started investing well before all of his debt was paid off … he should have started investing as soon as his expensive debt was paid off and left his cheap debt on a regimen of minimum payments.

The problem with this war is that it’s an unjust war; as TraineeInvestor said: “Debt is a tool. Paying it off is simply choosing not to use the tool.”

Yes, becoming debt free is simply a tactic

If you have to go and fight a war, don’t fight a war against debt …

… go and fight a war for investment 😉

Pay off debt or invest?

I’m publishing a whole series of posts targeting Debt … it has very little to do with conventional financial wisdom on this critical subject. Here is the second post (I have another one coming up, soon) …


Gen-X Finance is polling his readers as to whether they would prefer to pay down debt or save:

If you have both debt and a need to save money, how do you prioritize? Some people will pay off debt at all costs before saving a penny. Others will be fine getting by with minimum payments while dumping as much money into savings or investments as possible. While others try to do a little bit of both. That’s why the poll today asks how you view this subject.

You should go ahead and answer the poll.

Now, this is such an important decision – perhaps one of the MOST important mindset changes that you need to make if you want to follow in my $7 million in 7years footsteps – that, for my new readers, I will point you again to my trademark Cash Cascade™ system (don’t worry, it’s simple and free) that replaces the Debt Snowball, the Debt Avalanche and most of the other other debt repayment systems that you may have previously tried.

Here’s why it works:

People make the mistake of thinking that there is GOOD DEBT (typically, investment debt) and BAD DEBT (typically, consumer debt) … but, this is only true BEFORE YOU TAKE ON THE DEBT.

Once you are in debt, then there is only CHEAP DEBT and EXPENSIVE DEBT. Put simply, pay down your expensive debt, until only the single digit ones (on an after tax basis) are left, THEN start investing.

This goes against the ‘pay down all debt’ theories, but works both logically and practically. Try it … and, let me know how it’s working for you?

Becoming debt-free is a tactic …

My uncle had a wish: he wanted to stay healthy. He heard that eating apples is good for you (you know, ‘an apple a day keeps the doctor away …’), so he started eating apples.

If one apple is good, he thought, then two must be better. In fact, he started eating apples religiously. He got Vitamin A poisoning. He stopped eating apples.

There is such a thing as ‘too much of a good thing’ 😉

I sent out the tweet in the graphic at the top of this page because too many Twitterers/Bloggers – and their followers – eat too many apples.

Here’s what I mean …

If you’re healthy you get to run and run and run, just like a puppy does. Fun!

If you’re financially-free you get to do pretty much whatever your ‘freedom’ allows, and you no longer need to spend 8 hours a day (or more) at work for The Man. Whoohee!

But, being healthy and being financially-free are ‘wishes’ – something that you want. Just wanting something doesn’t mean that you’ll get it.

So, you eat an apple a day because a doctor told you it’s good for you … or you start paying off debt because a blogger told you that’s it’s good for your financial well-being.

But, the problem with these proscriptions is that there’s no prescription [AJC: yet another bad pun] … you need to be told exactly how much of a good thing is really a good thing, before you keep going and overdose!

You see, eating apples – as my uncle found – and paying down debt – as many blog-readers find out too late – can be good or bad for you, depending on how much you under- or over-do things. Eating apples and paying down debt are just tactics promising to help you get you to where you want to go.

With debt-reduction – as with apples – there’s an optimal point: it’s the point where it contributes most to your real goal.

If your wish is to become financially-free then your goal should be able to be expressed as a specific Number and a specific Date; you should apply debt reduction in such a way that it maximizes your chances of reaching that Number by that Date.

I have a hypothesis that the Number/Date bell-curve for my reader population – nay, the entire personal finance blogosphere’s readership – is well and truly centered where paying down debt only makes:

– absolute sense in the double-digits i.e. where most credit card, personal, and (many) auto loans sit today

– no sense (nonsense?) in the low-to-mid single digits i.e. roughly where home mortgage rates and student loans sit today

And, the remaining debts (say, between 5% and 10%), they can be paid off, if you have low financial aspirations but if you are aiming for $7 million in 7 years, I’m suggesting that these, too, need to be set aside for a while in favor of funding your latest startup and/or active investment.