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.

When should you take a loan instead of saving?

debt v savingsHere’s a commonly asked question:

In which cases should you take credit or a loan instead of saving up?

Len correctly answers:

When the price of whatever you are looking to buy is rising faster than the interest on the loan.

But, the answer that I want to focus on is that by popular financial blogger, Pinyo who says:

Buying a house at today’s interest rates is a good example of where taking a loan could be more beneficial than saving up.  You’re amortizing over 30 years and inflation would counter the interest expenses you paid over the life of the loan. In the mean time, you get to enjoy the house much sooner.

Whilst what Pinyo suggests is correct: real-estate is a great hedge against inflation; and, borrowing to purchase your home is probably the only way that most people will ever get to buy one …

… his comment actually fails to mention that it’s also a pretty good investment. Even your own home.

Let’s take a look at a simplified case of somebody purchasing their own first home (house or condo) for $100k, including closing costs. They put in a 20% deposit and take out a 30 year fixed loan, locking in at 3% interest.

Let’s also take Pinyo’s line that the interest rate just happens to offset 30 years of inflation (i.e. inflation also averages 3%), which is almost spot-on, based on the past 30 years’ average inflation rate.

Whereas Pinyo suggests that you are (a) offsetting inflation, and (b) enjoying your house …

… I think you are also making a great investment.

Here’s why:

– Over the 30 years, at just 3% inflation, your $100,000 home would have grown in value to $237,000

– Of course, in that same 30 year period, you would have also paid your bank $52,000 interest on that $80k loan

– Don’t forget that you put in a $20k deposit, which could have been earning interest elsewhere; let’s say that you would have averaged a 5% return on this investment, so your $20k could have grown to $86k.

The bottom line is that you will make an additional $17k profit, if you buy the house instead of just ‘saving’ the $20,000.

To me, this is a clear and tangible case where borrowing (to buy your first home) is better than merely saving …

What about the repairs and maintenance cost, you ask? And, the insurance, and the land tax?

My feeling is that these would be a lot less than the rent that you no longer need to pay …

… after all, you did just buy your own first home didn’t you? 😉


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 😉

… another man’s poison!

To some people, it seems that I promote high-risk strategies. For example, long-time reader, Josh says:

I wondered over to your blog to see what’s new and after reading a few posts I realized why I don’t visit anymore, and it’s because your articles are drenched in pro-debt/leveraged strategies. This is something I don’t agree with and don’t practice. I do understand the mathematical ramifications of using debt to leverage yourself, it’s just something I plan to do without.

Firstly, what Josh is saying isn’t quite true …

… in fact, I don’t recommend debt to anybody. What I have said is that I don’t believe in the anti-debt lobby.

There’s nothing evil about debt per se, it’s if/how/when you apply it that counts.

For example, I have variously had:

a) a little debt: on my various buy/hold properties

b) a lot of debt: in my finance company (for a finance company, cash is like stock … you need as much of it on hand as possible)

c) no debt: all of my other businesses were ‘bootstrapped’ and self-funded

I should point out that Josh is a stock investor; he has made a small fortune (turned a couple of $k into one $m or so while still at college) buying pharmaceutical ‘penny stocks’ … I wonder how many people would consider that risky?

One man’s ‘sensible investment strategy’ is surely another man’s poison 😉

Would you cash in your 401k to fund your new business venture?

There was a question on Quora that asked something along the lines of “what is the most overlooked factor in starting a business?”.

This applies equally to an online or offline business … and, I was surprised that none of the responses mentioned it:



In order to launch a business, you need to be able to overlook risk.

Even though risk can be managed, if you sat down to think about all the possible things that could go wrong with your proposed business, well, you would never start it.

So, I think you need to be able to overlook risk – and, move well out of your comfort zone (unless you are already into extreme sports and other forms of death wish!) – if you are to think about starting a business that consumes considerable time and/or money (no ‘hobby businesses’ here).

Hopefully, this now paves the way for a sensible discussion around a rather controversial Wisebread article sharing Darwin’s thoughts on How to Start a Business With Your 401(k).

Darwin’s view is that, rather than taking on expensive debt, it may be better to start your business by withdrawing all or part of your 401k using “a little known, but increasingly popular provision in the tax code referred to as the Rollover as Business Startup (ROBS). It allows someone to start up a new business venture with funds from an old 401(k) account without incurring the dreaded early withdrawal penalties meant to deter people from using their 401(k) accounts like piggy banks.”

A sensible – negative – response is offered by one reader:

To avoid going into debt is a pretty bad reason to raid your 401(k). If your business fails you can always declare bankruptcy – bankruptcy can’t touch most 401(k)’s – you’ll still have your retirement savings…roll it over into the business instead, have it fail…and you’ll have nothing.

And, I agree – to a point: your 401(k), although woefully inadequate for its intended purpose (i.e. ensuring your retirement) is useful as an insurance policy when all else in your financial life goes wrong.

Cashing in your insurance policies because you need money is the last thing that you should do!

But, this viewpoint ignores some basic realities:

1. Going into business, for a true entrepreneur (the type that can build a $7m7y business) is a “must do”.

Starting my own business was all I could think of for 4 years (yes, I was slow to act), and risking everything (career, etc.) was simply par for the course. I’m not saying this is ‘right’, just that it’s how an entrepreneur thinks.

2. Raising significant debt finance is almost impossible for a new business.

Sure, you can (and should) tap out your sources of traditional finance: refinancing your house (if you’re not already upside down on your mortgage); max’ing out your credit cards; trying for a personal loan (fat chance once the bank manager finds out what it’s for).

I do not think cost of the debt is an issue (if it’s available TAKE IT because it’s deductible and you’ll pay it off if your business is successful). I do think access to debt is … I think you’ll find it’s just not available; at least, not in the amounts required if your business requires access to substantial capital (e.g. for shop fit-outs, software builds, stock purchases, etc.)

3. Equity Capital can be equally difficult

The first place you should go for funds for your new venture is the 4 F’s: Founders (see above), Family, Friends … and, Fools. These days, Fools are very hard to find (they’ve already had their pockets emptied in the crash!) and Family and Friends are less likely to dig into their pockets than ever before.

So, that may leave your 401(k).

If that’s the only source of funds for your new venture, what will you do?

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 😉