Not a fan?

GREEDY-BANKIt’s fairly safe to say that Mike is NOT a fan:

I happened to stumble on this site doing some research on debt free. No wonder I’ve never heard of this site or even the radio show apparently associated with it. Anyone who thinks that living debt free is the wrong thing to do needs to have their head examined. That’s like saying Ohh we shouldnt live debt free we’re on the planet to make banks rich on our hard earned money. Nice mentality you got there. It just doesn’t hold any water. The question you should be asking yourself is would you rather live be constantly paying out your hard earned cash to banks making money off you not paying for your own assets or should you own your assets outright and control a greater portion of your hard earned cash? The choice IS obvious.

But, what of Mike’s aversion to paying the banks interest?

I look at banks a little differently to those like Mike who are averse to paying their interest, fees and charges …

… sure, I don’t like how they can mount up. And, I don’t like how the banks can make ‘super profits’ in good times and seem to get away with it. And, I don’t like those snooty tellers who look over their glasses at you, when you want to make a withdrawal, like they’re doing you some sort of favor by letting you have your money 😉

But, I can put that aside, when I realize that here is a partner who is willing to put up some – or even most (if it’s a real-estate transaction) of the capital to fund my latest entrepreneurial or investment endeavor, yet they want virtually no say in how I manage that business / investment once they have put their money in … and, I even get virtually 100% control over all of the daily management decisions and even, pretty much make the ‘sell’ decision on my own.

And, all they want is a few % per year return on the money that they put in … no share of the speculative upside!

Where else can you find a partner like that?

So, Mike, I ask you: what’s your objective?

– To get rich(er) quick(er)?

– Or is it to avoid putting any of your money into somebody else’s pocket?

I don’t mind which path you choose, as long as it gets you to your financial objective i.e. Your Number by Your Date …

… if not, you will do well in life – not just your financial life – to stop obsessing about what the other guy might be getting out of the deal, and start obsessing about what you might be getting out of that same deal 🙂

I wonder what our readers think? Tell us about your good/bad experiences with bank funding …

I think we’re screwed …

housing_crashIf you needed any evidence that the ‘global financial crisis’ – on a global macro level – and problems with the US real-estate market – on a global micro level – are still affecting people in the their day to day lives, you need read no further than Rischa in Seattle’s comment [AJC: I’ve added punctuation for your reading pleasure]:

From what I’ve read I think we’re screwed, but I’m not even sure what we can do. Here is the scenario: my husband and I bought this house about 10 years ago in the boom here; with both of us working we could afford the mortgage and our lifestyle easily. I’ve [since] been laid off and we’ve been living on my savings, which is now gone and I’m on unemployment, which is fast running out.

We’re about $100K upside down, we got a trad. loan 30 yr fixed, but without 2 incomes we’re sinking fast. We don’t necessarily want to stay in this house, in fact we want to move to a part of the country where the cost of living is less.

Any clues? What should we do? How do we get out of this when getting out would cost more than we have, even if we spent our retirement to get out? We would have less than nothing left!

Of course, it’s difficult to give Rischa personal advice – and, I wouldn’t do it – but, I could suggest that she go back to that post and reread the bit where I said:

Ask yourself the following TWO questions:

i) Can I afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer to either question is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

In Rischa’s case, the answer to the first question appears to be NO … and, she would prefer to be moving to a cheaper part of the country (and, cheaper house?), anyway …

So, it’s obvious that she can’t afford her existing house, but what would you do? Hang on to a losing proposition? Or, cut your losses?

Debt as a hedge against inflation?


Flexo (at Consumerism Commentary) wrote an interesting piece on debt reduction; in promoting his Debt Avalanche over the Dave Ramsey’s Debt Snowball, Flexo said:

One major problem I have with the snowball approach is that your largest balance may be significantly more expensive than your smallest balance. Today it is not difficult to find a default interest rate on a credit card north of 30%. There is no way in good conscience I could recommend holding off on eliminating a debt this expensive in favor of paying off a small balance with a 7.9% interest rate. The same goes for payday loans, whose fees can border on usurious if interpreted as interest rates.

I agree totally, but then reminded Flexo that there is a third method – one that I humbly invented – called The Cash Cascade which encourages you to consider what you will do AFTER you have paid off your debt … and, perhaps do some of that instead!

Flexo sent me an e-mail and asked me to to “describe at least a summary of [my] method in the comment”, which I did as follows:

We are all familiar with the concept of ‘good debt’ and ‘bad debt’, but most don’t realize that this is only a way of avoiding getting INTO (bad) debt … once we have acquired the debt, then we need to start thinking of debt simply as ‘cheap debt’ or ‘expensive debt’. The Debt Avalanche is clearly ideally suited to attacking the ‘expensive debt’ first.

However, there is another part to this: our ultimate financial goal is usually not to become ‘debt free’ (although, that may be a tactic that some would choose … not me!), rather to achieve financial independence, or wealth, or [insert your life-supporting goal, here], and often a part of the strategy will be to acquire SOME debt in order to get there while you are still young enough to enjoy life e.g. you might decide to take out a mortgage on an investment property, or a margin loan on stocks, or a small business start-up loan, etc.

Clearly, it would make NO sense to delay investing just so that you can pay off relatively cheap debt (e.g. student loan, mortgage, etc.) i.e. just to take out more expensive debt later (e.g. the small business loan) … instead, leave the cheaper loan in place and “pay off’ the more expensive loan by not taking it out in the first place!

Once you think about debt and investment as ‘cheap’ v ‘expensive’, it becomes easier to apply the principles of the Debt Avalanche to both debts AND investments 🙂

Not sure if my thought process was very clear, but it certainly stimulated an unbelievably clear comment, from another reader – Kitty – who said:

I would like to second 7million7years in that keeping fixed low interest debt around instead of repaying could be a valid investment strategy. One thing to keep in mind always is the possibility of future inflation and/or higher interest rates – a reasonable expectation nowadays.

If your debt is at 4.5% now, it may seem like higher than you can get on a normal CD. But what about 5 years from now? During the early 80s where you could get double digit returns on normal bank CDs people who had 30-year fixed mortgages at 9% were feeling very lucky… Long term fixed low interest debt is as much a hedge against inflation as buying commodities or TIPs. In fact I have a couple of multi-millionaire friends who took a mortgage on their vacation home when they could’ve paid for it in cash.

I don’t know if I would finance my vacation home – unless, I had something MUCH better to do with the money – but: “long term fixed low interest debt is as much a hedge against inflation as buying commodities or TIPs” …

… using debt as a Making Money 301 tool? Brilliant, Kitty!!

I only wish that I had thought of it, first 🙂

How the (not quite as) poor (as other) people make budgets …

OK, there’s no doubt about it: the financially dead do NOT keep budgets and do NOT control their spending, so you are definitely better off by following the Three Step Plan to budgeting simply explained in this video:

1. Have a Goal

2. Make a Plan (i.e. your budget)

3. Keep Track of every dime that you spend.


Except, that it won’t make you rich

… because you can’t save your way to wealth.

So, here is the Patented 7million7year 3 Step Plan To Budgeting Your Way To Wealth:

1. Work out what wealth means to you: i.e. find Your Number and Your Date

2. Choose your required Growth Engine

[hint: it will have a lot more to do with increasing income than it does to do with controlling expenses]

3. Do the No Budget Budget … once … that’s it!

Which method do you prefer?

New Reader Question about debt …

I am always pleased to receive questions and comments from readers – and, new readers in particular. For example, recently I have been in e-mail conversation with David, a new reader, who asks:

After spending half of my day reading various posts and links I have a better idea of where I need to be.  I do have a question – I have student loans that I unfortunately locked at a 9.9% interest rate back in the mid 90’s.  I still carry about 30k and I make about a $330 payment a month.  What is the best strategy for those?  I can’t refi them.  I can pay them off “quickly” but the money that I would be lopping off that is taken away from my nest egg and emergency funds.  If I pay them off on their schedule, it will cost me around $79k in the long run. What would you suggest?

While I’m not qualified to – therefore, don’t – give give direct personal advice of the financial or any other kind, I can use this question as ‘inspiration’ for this, more general, post …

This is a common problem, facing most folk these day … not specifically the student loan, but debt in general. And my response is generally the same: it depends 🙂

And, the thing that it depends on is actually two things, not one:

1. Do you have ‘spare income’ or cash floating around that you COULD be applying to this loan?

If not, then you need to keep paying the loan according the schedule and doing your level best to find some additional money through increasing income (MM201) and/or better personal money management (MM101). But, if you do have some spare cash floating around then you need to ask yourself the following question …

2. Where else could you put the money that would return more than 9.9%?

This is really a simple question, so you don’t need to beat yourself up about the answer …

If you want to start a business that can return, say 50+% if it’s successful, then you may be better off keeping the loan in place – making just the required payments, for now – and putting your spare cash towards startup/working capital for your business.

But, if you are thinking (instead) of paying down your home loan, with its current interest rate of 6% (probably at least partly tax deductible) then I would suggest that you instead pay off the student loan.

And, if you had a car that you absolutely had to purchase and were thinking about financing it at, say, 11%, then I would instead suggest that you pay cash for the car and keep the student loan in place.

The decisions, to me, only become more ‘difficult’ if you have no clear idea of a better use for your money other than “Maybe investing in something one day” … in which case, I would take the ‘sure thing’ i.e. pay off the ‘student loan’ debt,


The available options are so close in interest rate earned or spent e.g. should I pay down the 9.9% student loan or buy some units in an Index Fund that should return a bit over 9.9% over the next 10 or 20 years …  in which case, I would again take the ‘sure thing’ i.e. pay off the ‘student loan’ debt.

Other than that, simply apply the principles in this recent post and you won’t go too far wrong …

BTW: don’t forget to compare interest earned and/or spent AFTER TAX. To me, a rough estimate (rather than paying for a consultation with your accountant UNLESS the decision is major or strategic) is probably usually good enough … but, when in doubt, work it out WITH YOUR ACCOUNTANT.

Oh and one more ‘trick’; if you have another asset that you can acquire new debt on to pay off the more expensive old debt, can/should you do it?

For example, if David has a house with ‘spare equity’ can/should David refi the house and pay off the student loan entirely. At an effective current (tax deductible) interest rate on the refi of, say, 6% (compared to a ‘locked in’ 9.9%) the answer is most likely a resounding YES, however, now we have to think about locking in and term:

The student loan is likely to be locked in to a repayment schedule that will see it paid off in just a few years, but a mortgage will probably be offered at 15 to 30 years to keep the repayment schedule low … if the purpose if simply to repay the student loan, then you should divert the money that you would be using on a monthly basis to repay the student loan to repaying the mortgage (i.e. pay off the mortgage with the original mortgage payments PLUS the former student loan payments).

Because the combined interest rate is now lower but your repayments are the same as before, you should actually be paying debt off at a slightly faster rate …

Of course, if you do have a hot new business or investment idea, then you may instead refi the house, pay off the student loan and apply any spare cash (over and above what the bank says that you HAVE to pay on the mortgage) to building that little ol’ warchest … but, this is an advanced – and more risky – Making Money 201 concept … only needed if your Number says so 🙂

Are you carrying expensive debt?

picture-2Sometime ago, I uploaded a video that explains my unique debt repayment strategy – after all, EVERY self-respecting ‘finance guru’ has one these days 😛 –  and, I wrote a follow-up post explaining the concept of ‘expensive debt v cheap debt.

Money Funk – and, I thank her for (a) taking the time to run the numbers, and (b) for taking the trouble to write about what she found (in not just one post, but two on her own blog) – says:

Now, read the post and reread the post. It took me a couple times to completely follow. But, I will tell you that I am really glad I did. Why? Well, because it could end up saving me $35,328!

I recommend that you read Money Funk’s post – “and reread the post” – to see how she thought through the numbers …

… but, for those of you – like me – whose eyes glaze over as soon as you see a bunch of numbers with IF’s and THEN’s liberally interspersed, simply think about the whole subject this way:

Take a look at the interest rate on the debt that you are thinking of paying (e.g. 2.5% on a student loan; 5.5% on a mortgage / housing loan; 19% on a credit card debt) and decide whether you would be better off leaving that loan in place and investing the payments that you would have made instead.

– If you could earn 8.5% on that money in the stock market, why wouldn’t you do that?? 8.5% is better than either 2.5% or 5.5%

– Alternatively, if you are thinking of borrowing to buy an investment property, why would you pay off a 2.5% loan just to then take out a 6.5% ‘investment loan’?

Oh, and if you are not thinking of buying an investment property instead of paying down any reasonable, low-cost (eg mortgage or student loan) debt … think again!

– However, if you are carrying a 19% credit card debt, what are you thinking of: pay that sucker off ASAP!

BTW: you may be wondering what the Debt-to-Income-Ratio pie chart on the top of the page has to do with anything?

I ‘lifted’ it off MoneyFunk’s site before she changed the pie chart to this one:


Now, I can’t comment on the first version, but I can on this one: even though Motley Fool suggests that it’s OK to carry 15% of your income in servicing ‘bad debt’, the ‘correct’ ratio of bad debt to income is 0% … you should carry NO bad debt.

On the other hand, if you DO currently have ‘bad debt’ (eg consumer loans, car loans, mortgage – this one is in the ‘grey area’ between good/bad debt – or credit cards) then the correct comparison is how much expensive debt you should carry v cheap debt … the answer again, of course, is none.

So, the real comparison is how much cheap debt you should then carry, but that’s a whole other enchilada that I have some of my best people working on for you …

… stay tuned 😉


This is like the closing credits: the reward for people who don’t leave the movie until the VERY end … or, in this case, actually for people who read the WHOLE post:

I got top billing on a site called “hahagood” … I sincerely hope it’s a foreign-language version of this site and not a Chinese porno site 🙂

Guest Post by Andee Sellman: What you really need to know to win the personal finance ‘game of life’ …

This is my third ever Guest Post: Andee Sellman agreed to it, after I had come across his blog and linked to one of his videos on this site.

Andee soon contacted me and we realized that we both live in the same city (Melbourne, Australia … well I split my time between Melbourne and Chicago) and share similar philosophies on personal finance.

This ‘video post’ explains the ultimate goal of Andee’s unique Personal Finance game (called Where’s The Money Gone).  Andee’s video can be accessed by clicking on the image below; I really think that you enjoy it …


picture-42Many people have been fooled by the financiers over the last 15 years of boom into looking at the wrong ratios. As a result they don’t know whether they’re being fiscally responsible.

Have you heard of the ratio 80% LVR. This stands for 80% loan to value ratio. Another way of expressing ratio is this :-  400% Debt to Equity!!!

If people continually focus on looking at the lower ratio they will be lured into buying overvalued assets, funding them with too much debt and then wondering why they’re struggling with their cash flow when they’re supposed to be feeling wealthy.

In this video I explore a better ratio to focus on. This means wealth creation is built more sustainably and with less risk.


Thanks for the video, Andee!

It really helps to explain why people go broke in buying too much property (home and investment) and/or other investments on finance, even though we’ve always been told to borrow more to invest more. In upcoming posts, we will explore the link between Andee’s ‘twin equations’ and our own Equity and Income Rules …

BTW: Andee filmed this video in the lovely (if a bit dry due to the extended drought) Stephens Reserve – a section of parkland near his office in Vermont (an outer suburb of Melbourne); Andee plans to do a ‘video tour’ of Australia, filming a number of videos at scenic locations around the country … or, perhaps the world!? If you want to keep an eye out for these videos – which are sure to be instructive and entertaining – I suggest that you check in at Andee’s blog from time to time.

The Cash Cascade ™

I wrote a series of posts about Dave Ramsey’s Debt Snowball, and have found this great summary / illustration on Blueprint for Financial Prosperity’s blog (does he just sign his checks BFFP to save ink?):

One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.

Here’s a real life example; here are your three debts and minimum payments:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment
  • $1,500 @ 12.5%, $75 minimum monthly payment + EXTRA PAYMENT

The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment + $75 + EXTRA PAYMENT
  • $1,500 @ 12.5%, $75 minimum monthly payment

I have only added the words “EXTRA PAYMENT” to both examples, because I want to clarify – then expand upon – BFFP’s example.

First, though, what Dave Ramsey is saying – and, what BFFP is trying to illustrate – is the concept that you take one of your debts (the highest interest rate in the traditional ‘Debt Avalanche’ or the smallest balance owing in Dave Ramsey’s more psychologically-friendly ‘Debt Snowball’ method) and pay that down completely … merely making the required minimum payments on any other loans (but no more!) to stop them from going into default.

The credit card companies will love you for this!

Then when that loan is paid off in full you apply the payment that you USED to make on the first loan that you tackled to the next remaining debt, and so on …

… it ‘snowballs’ because you are applying more and more to each remaining debt, while never having to commit more (or less) to debt servicing than when you first started budgeting.

So, in both examples we are paying $775 (i.e. $500 + $200 + $75) towards debt repayment until all debts are paid off … THEN – conventional financial wisdom will tell you – you get to start INVESTING that $775 a month and you are FINALLY debt free and on your way to … what?

Well, let’s go back and make the small correction: if you only make the minimum payments, you will never pay off any of the debts (or, way too slowly), so you need to find some extra money and make some extra payments to the first loan that you decide to tackle; let’s use an example of $225 a month as an extra payment …

… and, from now on you commit to that monthly $1,000 i.e. $500 + $200 + $75 + $225 EXTRA PAYMENT + C.P.I. + 50% of any ‘found money’ (second jobs, part-time business income, loose change, IRS refund checks, etc., etc.) for your entire working life!

So, we are on the road to success! Or, are we?

The problem is that we have to decide where we’re heading: if our aim is to become a Ramseyesque Debt-Free=Happy clone, then well and good. Your financial plan is set.

[sign off now]

But, if we intend to get rich(er) quick(er)™ we have two huge limitations, neither of which the Debt Snowball or Debt Avalanche address:

1. Time to invest, and

2. Money to invest.


We all know the time value of investing early and investing often:

If we lose just 10 years to our investing plan by delaying investing while we pay down ALL of our debt and/or pay down our mortgage we can halve our potential return.

Do you think that might be significant?

So, we don’t want our debt-repayment strategy to unnecessarily delay our investment strategy.


Where are we going to get the money to invest?

Sure we can accumulate $1,000 a month (after paying off debt) – and, grow that amount through C.P.I. and ‘found money’ strategies -but, will that really set us off on the path to financial riches?

The same graph shows that for every $1,000 A YEAR we invest, we can expect $100,000 after 20 years … so, our $1,000 A MONTH strategy should yield $1.2 Million over the same time period … unfortunately, that won’t be enough for a DEPOSIT on the Number that you really need …

… and, inflation will take at least a 50% chunk of that (not to mention taxes)!

So, the solution for most people – who don’t want to lower their expectations to match this depressing, but debt-free (!) scenario – is to move INTO debt … to invest!

This is so-called ‘good debt’ and I’m not sure what Dave Ramsey and Suze Orman’s take on this is, but most financial pundits call it ‘good debt’ for a reason. Assuming that you agree, read on [AJC: if not, I’m guessing that you hit <delete> about 4 or 5 paragraphs ago]

So, here’s what we need …. a different mind-set:

Since we already know that we will more than likely need to incur SOME ‘good debt’ as part of our investment strategy (i.e. some safe level of leverage for investment purposes e.g. a loan on a rental property) …

why pay off OLD debt now in order to accumulate NEW debt later?

It doesn’t make sense, does it?

We merely waste time and money … instead, we should resolve the following:

1. To treat all Consumer Debt as ‘bad’ and incur no further such debt, unless it’s not really Consumer Debt at all (e.g. we need to buy a car to run our catering business, and public transport or a bike really won’t cut it)

2. To apply the minimum required payments + extra payment(s) + c.p.i. + ‘found money’ not merely to the lesser goal of paying down debt, but to the greater goal of helping us get to our Number (i.e. the financial representation of our Life’s Purpose [AJC: if you don’t buy into that philosophy, then simply insert the words “helping us become financially free”])

3. To, from this day forth, look at all debt as an INVESTMENT in your financial future: and, simply ‘invest’ where you get the greatest returns: is that in paying off an old debt? Or, is it in acquiring a new debt?

Example 1

In the example above, we have three debts of 20%, 12.5% and 10% (are they tax deductible? If so, look at the after tax cost which will be 25% to 35% lower than the nominal interest rates circa 14%, 8.5%, and 7% respectively) …

Compare these interest rates to the cost of money for the types of investments that you want to make …

… in this example, all three are higher than current mortgage rates so you will probably want to keep paying them off (although a good argument can be made for paying off the 20% loan first, then buying an investment property BEFORE paying off the others).

Example 2

Let’s make two changes to our example:

Let’s assume that one of the loans is a 2.5% Student Loan, and swap the amounts owing (so that the Student loan is now the ‘biggie’) and, let’s assume that we have at least 5 more years before it HAS to be paid back (so we have time to make an investment work for us); here’s our starting position:

  • $1,500 @ 20% APY, $500 minimum monthly payment + $225 EXTRA PAYMENT
  • $4,000 @ 10%, $200 minimum monthly payment
  • $10,000 @ 2.5%, $75 minimum monthly payment

In this case, we tackle first the 20% loan; I can’t imagine an ‘investment’ that will provide such a quick & safe 20% post-tax return! Then, we tackle the 10% loan.

Again, an argument could be made for leaving it in situ; however, it is only $4k – and, we’ll pay it off in just 4 months – so let’s go ahead do just that:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment
  • $10,000 @ 2.5%, $75 minimum monthly payment
  • $10,000 Reserve #1 @ (1%)  + $200 + $500 + $225 EXTRA PAYMENT

See what we are doing?

Once we have paid off our two HIGH INTEREST loans, instead of paying down the low interest student loan, we continue to make its minimum monthly payment, and instead apply all of the previous / extra loan payments (from our OLD loans) to building up a ‘reserve’ in a bank account (it pays us a – low – rate of interest!) …

… at this rate, we will have a deposit on a small rental (or our own first studio apartment) in less than a year, then our financial picture will look something like this:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment + $200 + $500 + $225 EXTRA PAYMENT
  • $10,000 @ 2.5%, $75 minimum monthly payment
  • $10,000 Reserve # 1 @ (1%)
  • $40,000 @ 6% FIXED, $240 required monthly payment
  • $10,000 Reserve # 2 @ (1%) + $185 + $500 + $0 EXTRA PAYMENT + $185 Rent

Keep in mind that if you used Reserve # 1 to build up a deposit on a small apartment to live in, then you will have no rent to pay, so you can apply part to home ownership expenses (rates/utilities/taxes) and part towards your next Reserve!

And, if you bought a rental, then you may be in an excess rent situation and have more to apply to building your next Reserve, as well … if not, then you will need to decrease the amount going towards your next reserve to cover any rental shortfalls (e.g. mortgage payment deficits, vacancies, repairs & maintenance fund, etc.).

Now, you know why this is not a Debt Snowball, a Debt Avalanche, or even a Debt Meltdown:

It’s the Cash Cascade …

… the new way to look at paying down debt!

In the two years that it would have taken you to pay off your Student Loan and buy your first property, you now own two properties and are well on your way to financial freedom!

What do you think? Will it work for you?

The correct way to look at debt …

BradOK asks:

What’s a better use of my money – pay down debt or invest it in the market?

To which JillyBean responded:

At what rate of interest is your debt? How much debt do you have? Do you have an emergency fund? If you invest your money, what is the purpose for the money — short term or long term? The markets are on a downward spiral and very volatile — it might be more prudent to answer the above questions to determine the answer for the actual question.

You could always compromise and do both! It never is bad to pay down debt.

But, I am always working from the assumption that you want to get rich /stay rich …

… if that’s also your mindset, you might have more clarity if you rephrased the original question as “what’s better, to INVEST in debt or INVEST in the market?”

Once it’s clear that you are making an INVESTMENT every time you pay off debt – even personal debt – or, decide not to, then you will realize that you simply need to consider relative returns.

Then it will suddenly become clear that INVESTING in debt returns you a guaranteed rate equivalent to the interest rate (plus ongoing fees, if any) being charged. On the other hand, investing elsewhere MIGHT return more, over the long-term.

So, your real question that you need to answer is: “What investment will give me a greater AFTER TAX return than my highest interest rate currently outstanding debt?”

If you can find one (and, you have the required skills/interest/knowledge/stamina) then invest in that, otherwise pay down some debt.

Naturally, start with the highest interest rate debts first and work your way down (remember the ‘debt avalanch’?)

The Great Debt Repayment Fallacy … don't fall for it!

Everybody knows about ‘good debt’ and ‘bad debt’, right? And, we all know – and have committed to memory – Personal Finance Prime Directive # 1:

Eliminate All Bad Debt Now … Before Doing Anything Else!!!

This may be the current Personal Finance mantra, but, if you happen to subscribe to the same view, then read on because this post could be the most important piece of wealth-building advice that you will ever read!

But, first …

That simple and clear ‘PF Directive’ was the assumed premise behind a recent (and very good, I might add) post on The Simple Dollar that I want to delve into a little more deeply than usual because it brings out a critical wealth-building point that may not be obvious to all. In that post Trent said:

A reader wrote in recently:

I have kind of a weird situation with our 2 credit cards, and wanted to see what you thought. We have one card (Citi) with a total balance of $4,800. $3,800 of this is a balance transfer that is at 2.99% until paid off. The remaining $1,000 is at 13.49%. Of course, all principal payments are applied to the lower rate debt first. Our other card (Chase) has a balance of $5,700, and is at 0% until September 08, when it goes to 8.99%. Which card do you think is best to “attack” first?

After reading this email, I thought it would be a good time to take a more general look at comparing the debts you owe as well as how to construct a healthy debt repayment plan.

Trent then proceeded to outline a very good and pragmatic approach to dealing with these, and any other, debts … a plan that involved: 

A few sheets of paper and a pen; the latest statement for every single debt; making the first list; ordering all of the debts by their current interest rate; looking for ways to reduce the rates, focusing most strongly on the highest current one; when you’ve reduced rates, making a new list reflecting the changes; dealing debts that are set to adjust in the future; directing all of your extra payments towards the top debt on the list; when a debt vanishes, crossing it off and feeling good about it; updating the list when you acquire a new debt; and, updating the list when one of your debts adjusts to a new rate

Before I weigh in on this, let me ask you a Very Important Question:

Do you really just want to be debt free or do you want to be rich?

I know that sounds self-evident, but stick with me … if you just want to be in the top 5% of the US population and retire on $1,000,000 in, say, 15 years then by all means, do the Dave Ramsey, Suze Orman, and/or Oprah ‘debt diets’:

That is, save and be debt free (including your own home) … whoohee! … by the time you ‘retire’ [read: work part-time in Costco handing out free food-samples until you’re 75], you’ll be living on the equivalent of $15,000 today  and hoping to hell that the government can still afford to pay you social security!

It’s OK if you slavishly follow this thinking: it’s the Conventional Wisdom …

It’s just that if you want … nay, need … to be rich(er) and retire soon(er) then you’re going to need unconventionally large amounts of money in an unconventionally rapid timespan, and that’s going to take some Unconventional Wisdom!

You see, I believe that being debt free and being rich are [almost] mutually-exclusive!

This is a pretty controversial view, I should think … but, I will even go so far as to say that it is [almost] impossible to become rich without using debt: debt to fund your business (working capital finance and/or leases on equipment and/or leases on vehicles, etc.); debt to fund your real-estate investments (fixed interest mortgages and/or interest-only funding); debt to fund your stock purchases (margin lending); etc.

Hold on, all the Personal Finance writers/bloggers out there say:

We can put all of the above examples in the ‘good debt’ category and we already agree that they are OK …


But, then they always add:

… but, ‘bad debt’ is ‘consumer debt’ (credit cards, student loans, car loans, etc.) and we all know that our Number One Personal Finance Objective is to wipe Bad Debt out, right? After all, it’s not called ‘Bad’ for nothing! Right??!!

Well, not necessarily … sure you shouldn’t get yourself INTO any of this Bad Debt … but, once you have some (you naughty, failed human being, you), you need to mix it with your Good Debt and revisit Trent’s Plan with ALL of your debts in hand … both ‘Good’ and ‘Bad’.

Look at it this way, once you find yourself with a mix of both Good (appreciating and/or income-producing assets) and Bad (depreciating, consumer goods) Debts, the only things that matter are:

1. Paying off the Dollar Value of the Bad Debt as quickly as possible, and

[AJC: Here is the key … its in the “AND]

2. Paying off the highest after-tax interest rate loan off first.

So here was my advice to the person who asked the question on Trent’s post:

Interestingly, in the reader’s case (if I read correctly) his ‘consolidated’ card is at a Combined Effective Rate of only 5.2% … because he can’t attack the 13% portion until he pays off the 2.99% portion I would do the following:

1. Pay off the other card first, then

2. Buy an investment using the money that he would have paid the 5.2% debt off with …

… after all 5.2% is a very low rate of interest!

To clarify: I would not pay either card when interest rates are under the standard variable mortgage rate … I would be financing new real-estate, or paying down the mortgage on my existing (IF I’m not breaking the 20% Rule). The plan I outlined above starts when the 0% period ends … until then, pay off NEITHER card IF you have a more productive use for the money!

What does this mean for the rest of us?

i) Don’t get INTO Bad/Consumer Debt … save and pay cash for any ‘stuff’ (cars, vacations, furniture, ipods, computers, etc.) that you want.

ii) Once you do get INTO Bad/Consumer Debt … don’t be in such a hurry to get out of it; compare the cost of your Student Loans; Ultra-Low-Honeymood-Rate credit-cards; Super-Low-Suck-You-Into-Buying-More-Car-Than-You-Can-Afford Interest Rate car loans; etc. against the after-tax cost of the mortgage that you have on your house and/or investment properties (or the interest rate on your Margin Loans for your Stocks; or your Working Capital Finance for your Business; etc.).

iii) Work out a repayment plan as though you were going to pay INTO that Bad/Consumer Debt … instead, pay an equivalent amount off against your highest after-tax interest rate loan across your entire Good/Bad Debt portfolio.

iv) Reevaluate at the earlier of Quarterly (i.e. every 3 months) OR when one of the interest rates on ANY of your loans changes OR [yay!] when you have paid one of your loans off.

v) If you don’t want to (or can’t) get out of a higher-interest loan early using (iii) then compare the cost of the lowest-interest loans that you have (regardless of whether they are Good/Bad) against the current FIXED interest rates for new loan on a new investment … if LESS, buy new instead of pay off old.

Remember: The Object of Personal Finance is to end up with MORE money … the object isn’t to SAVE money, PAY off debt, BUY a house, START a business … they are all just all steps along the way.

If you want to get Rich(er) Soon(er) never, ever confuse A Means To An End with The End

… now, let the flames begin!



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