The true cost of debt …


Have you cast your vote yet?

Deal or No Deal … YOU DECIDE

Click here to vote!


In my post about debt, I said that it is not always correct to simply pay down old debt … in this post, you will see that it’s rarely ever correct.

First, let’s look at Jeff’s comments, which summarize the traditional view that it’s all about interest rate comparisons:

My opinion is to still compare your debt interest to prevailing debt rates (is it cheap money compared to what else is available?), how does inflation affect the rate (cheaper future dollars point again) and can I out perform the debt rates with the investment opportunity that is competing for this money.

Without the tax advantage, I’m more inclined to pay off the debt, i.e. lower tolerance for high debt interest.

I haven’t done any math on it…yet, but my gut feel is that 6% or higher on the debt and I’d be giving serious thought to paying off the loans.

This may be true, Jeff, if all else is equal

… but in the ‘real world’ of investing, you will find that all else is rarely equal!

You see, I don’t look at interest rate and cost anywhere near as much as I look at utility – a concept that I introduced in this post: if I am serious about investing, I am struggling to find a scenario where putting my money INTO reducing leverage (by paying down existing loans) returns more than taking on new ‘good’ debt …

…. or, leaving old ‘bad’ debt in place, as long as it is cheap’ish and, much more importantly, available!

I’m sure that our resident real-estate experts (e.g. Shafer Financial) could point you to 1,000 examples where it is still viable to maintain debt of 8% – 15%+ as long as you could find cash-flow positive real-estate that appreciates at not much more than inflation.

It doesn’t even need to be real-estate, but it does depend on what you are prepared to invest into; e.g. assuming Michael Masterson’s numbers:

  • CD’s return 4%, so I would pay down the 6%+ debt
  • Index Funds return 8%, therefore, I would be inclined to keep the debt if it were very close to 6%; anything above and we would have a more difficult decision
  • Individual Stocks return 15%; I would buy the stocks (and, probably margin borrow into them as well), but that’s just me … Warren Buffett would say ‘never borrow to buy stocks’, so you have a ‘philosophical’ decision to make
  • Real-estate (together with stocks) returns 30%; @ 6% I would keep the loan (for as long as possible!) and buy the real-estate
  • Businesses return 50%+, so I would keep the loan in place (again) and use the ‘repayment money’ to help start up

Besides the obvious tax implications (e.g. CD’s and Index Funds – depending upon whether they are inside or outside a 401k – could become ‘line ball’ with paying off the 6%+ debt (IF it were pretty close to the 6% mark) …

BUT, you have highlighted a more important flaw in my argument: this table only looks at the use of the money; what if I could get a cheaper source of funds by paying down the old debt then acquiring new?

Great argument, in theory, but let’s see how it stacks up in the ‘real world’ … the simple question is: can we refinance or otherwise acquire cheap, new debt (thus allowing us to pay down the expensive, old debt) as Jeff suggests?

Let’s see:

CD’s: I don’t see any easy way to finance except with personal loans, credit cards, a refi or HELOC over our home, so I would say let the debt ride. But, the list above suggests that this would a recipe for losing money, anyway, because of the low returns.

Index Funds: possible to borrow on margin (i.e. finance) through a brokerage account (but, not in your 401k) but only to a max. of approx. 50% so you would still need to come up with the other 50% elsewhere.

Individual Stocks: same as with Index Funds (e.g. I am 100% financed in the US market through a combination of HELOC and margin loans).

Real-Estate: usually able to refinance, so I would agree with you to “compare your debt interest to prevailing debt rates”; other than right now, 6% is extraordinarily low historically … 8% – 10% would be closer to my refinance decision-point.

Small Businesses: very hard to finance except with personal loans and credit cards, so I would say let the debt ride if you were highly enthused and confident of success.

In other words, finance is simply not readily available on most investment choices available to us.

So, the questions that you need to answer – probably in this order, Jeff – are these:

1. Do I want to get rich(er) quick(er)?

2. If so, am I prepared to increase – or, at least maintain – leverage by borrowing for investments?

3. If so, am I prepared to make the mental leap of moving to the concept of ‘pools of debt’ and ‘pools of equity’ by not actually having the debt entirely on the asset that I am acquiring?

And, more importantly:

4. Is new debt available to make the investment/purchase (if so, is it cheaper than my current debt)?

5. Does the investment/asset that I am considering acquiring return more than my current (or new) debt?

If you don’t get past Question 1. then paying down debt is the only Making Money 101 strategy that you need to be concerned with … otherwise, I don’t really see this going half-way 😉

Deal or No Deal – Part 3 – Reader Poll

Late last year, I asked you (a number of times … just like Howie Mandel) …

…. Deal or No Deal?!

What would you have done [AJC: if you haven’t yet ‘cast your vote’, please go back to this post and drop a comment]?

We know that Ms Tomorrow Rodriguez (sounds like a character out of a James Bond movie)  said “No Deal!” to the miserly Banker’s’ offer that only paid out 1-in-3 for a 50/50 chance …

… Vote 1 for the ‘math kings’!

But, look at the situation that she’s faced with right now (in the photo above):

4 suitcases left: 3 of them contain ONE MILLION DOLLARS and 1 contains only $300!!

Ms Rodriguez – with the odds clearly stacked in her favor – has two choices:

1. Take the Banker’s Offer of $677,000


2. Say “No Deal” and select just one more suitcase (then she will be presented with another offer)

Deal or No Deal?

Let’s examine the options:

1. Take the $677k and run!

OK, the banker has offered $677,000 but there are 4 suitcases left of which three contain $1 Million and one is a (virtual) blank.

That smells like a 75% chance of $1 Million to me … ‘worth’ $750,000 (any maths whizzes out there to counter this?) … seems to me that the Banker is short-changing Tomorrow Rodriguez by $73,000 buckaroos!

2. Select just one more suitcase and see what happens next (after all, she can’t lose on the next turn)

Well, here is the problem … unlike any of the lead-up turns, this time there is only ONE non-million case left; so, there are actually two possible outcomes here:

i) Tomorrow selects the one suitcase containing the blank (i.e. $300) which means that she automatically wins (there are only 3 suitcases left … since each would then have to contain $1 Mill. she can’t lose)


ii) Three times more likely, Tomorrow selects one of the three suitcases that contain $1 Million and the chance of winning on the next round drops from 75% to 67% (3 suitcases left: 2 contain $1 Million and 1 contains $300 only)

The significance?

From this round on, the Banker Deals can only get worse, because the next round after this one would leave just 2 suitcases (assuming that she hadn’t won by then) … or, a 50/50 chance (and, we’ve already seen how much the Banker will rip her off on that)

In fact, Tomorrow is effectively paying for each ‘roll of the dice’ from here on in … whether she realizes it or not …

So, if she turns down $677,000, Tomorrow is really saying: “$1 Million or Bust … I’m going all the way, Baby!” … because she will surely turn down the later, much lower offers (been there, done that!) as well.

So, Ms Rodriguez really has just two practical alternatives:

1. A guaranteed $677,000 if she walks away right now


2. A 75% chance of winning $1 Million AND a 25% chance of walking away virtually empty-handed

Deal or No Deal?

Just like last time, make a vote & drop your vote into the comment section below (I’d love to hear your reasons) … next week, we’ll check out what our readers had to say … it should be interesting!

In the meantime, do you want to know what Ms Rodriguez chose? Do you agree?

A little perspective …


For a bit of fun, I typed in an annual income of $220,000 into this handy little online calculator, and it shows that I’m the 107,565th richest person in the world … whoohoo!

Now, if I typed in my real annual income, I think that I could jump myself higher up that list … and, if I factored in that I get that money mainly passively, well ….

Reminds me of an interview that I saw with Guy Laliberté, founder of Cirque Du Soleil, who went from street performer (read homeless hustler) to sharing the same level of wealth as Oprah.

Now, that’s not the bit that blew me away; what did was that they were sharing something like 160th place on Forbes’ list of the richest people in the world: Oprah … Cirque Du Soleil Man … and, they ONLY get to be joint 160th (approx.) on the list??!!

Who are these other dudes between them and Bill Gates?!

So, it’s really good to be able to put things in perspective and realize that if you are earning almost ANY regular salary, you are in the Top 10% of the richest people on the planet:

The Global Rich List calculations are based on figures from the World Bank Development Research Group. To calculate the most accurate position for each individual we assume that the world’s total population is 6 billion¹ and the average worldwide annual income is $5,000².

Below is the yearly income in percentage for different income groups according to the World Bank’s figures³.

Percentage of world population Percentage of world income Yearly individual income Daily individual income
Bottom 10 percent 0.8 $400 $1,10
Bottom 20 percent 2.0 $500 $1,37
Bottom 50 percent 8.5 $850 $2,33
Bottom 75 percent 22.3 $1,487 $4,07
Bottom 85 percent 37.1 $2,182 $5,98
Top 10 percent 50.8 $25,400 $69,59
Top 5 percent 33.7 $33,700 $92,33
Top 1 percent 9.5 $47,500 $130,14

The world’s distribution of money can also be displayed as the chart below.

¹ 2003 world population Data Sheet of the Population Reference Bureau.
² Steven Mosher, president of the population research institute, CNN, October 13, 1999.
³ Milanovic, Branco. “True World Income Distribution, 1988 and 1993: First calculations based on household surveys alone”, World Bank Development Research Group, November 2000, page 30.

So, realize that UNLESS YOU ARE PLANNING TO DEVOTE SERIOUS SLABS OF YOUR TIME AND MONEY TO WORTHY CAUSES this blog and everything we are doing here is about as useful as a blog on whittling … and, probably a darn site less so, because there’s nothing inherently of artistic merit in even the best-crafted bank account.

How much does it take to feel wealthy?

The answer is “about double” 🙂

But, that’s not really a tongue in cheek question / answer, it’s actually scientifically researched and verified fact …

… let me explain.

Most people want to become rich (when we strip away the houses, cars, vacations, sex, drugs, rock and roll [AJC: Boy, I must lead a great life!]) simply to feel secure … to stop having to worry about money.

So, the definition of ‘rich’ for most people is related to how much more money that they feel that they would need in order to stop feeling financially insecure. And, that always seems to be about twice what you currently have; take a look at this report by MSN Money (if anybody can find the base source, please send me the link … I hate to quote quotes).

  • Those who earned less than $30,000 thought that a household income of $74,000 would qualify as rich.
  • Those who made $30,000 to $50,000 said an income of $100,000 would be rich.
  • And people in the top half [$50k – $100k+] of earners were more likely to say that an income of $200,000 earns you the right to the R[ich] word.

So, it seems that no matter what income level you are on, you need two (to perhaps three) times that in order to feel ‘rich’.

Perhaps, you feel that it would be different if we weren’t talking penny-ante incomes here, and jumped straight to millionaires and multi-millionaires? Surely, things would be different for them?

Well, not so … according to Robert frank, Author of Richistan, most of America’s Ultra-Wealthy still consider themselves as ‘middle class’ and would need “about twice what they already have in order to feel wealthy”.

So, this is just another reason why picking a random income or net worth $$$$ target and calling that ‘rich’ doesn’t cut the mustard … you’ll never be relaxed with your level of wealth, no matter how much you have.

No, what you need to do is:

1. Understand WHY you need the money: we call this Understanding Your Life’s Purpose

2. Understand HOW MUCH you would need so that you would be free to LIVE your Life’s Purpose: we call this Calculating Your Number

… and, when you finally reach your Number, not worrying about chasing more, because that’s about as sensible as a dog chasing it’s tail!

The definition of insanity …

“Insanity: doing the same thing over and over again and expecting different results.”  Albert Einstein

Thankfully, this blog isn’t for everybody … only those who want to get rich(er) quick(er) … I’ve proved that it can be done successfully, and I am conducting a ‘grand experiment’ at one of my other sites to prove that it’s not just luck and that others can do it, too.

But, the vast majority are still in the ‘work for 40 years and hope to have saved enough’ mindset … and they have worries of their own, as this recent Gallup Poll showed:

Of course, recent economic woes are probably ‘skewing’ this a little … but, think about it – most aren’t retiring tomorrow, or even in the next 10 years, so markets will have plenty of time to boom and bust again for them.

No, the problem is more endemic: most people simply don’t think that they will be able to retire happy or comfortably – and certainly not wealthy – despite the ‘formidable’ array of ‘retirement weapons’ at their disposal:

So, if the majority of people are using these tools and the majority of people believe that they won’t work for them …


Surely, at some level, these people know that these tools – as I have been hammering home in this blog for some months now – simply won’t do the job?!

Let’s take a look:

1. 401k’s – High fees; low returns; lousy investment products on offer:

STRIKE 1 – I have never had a 401k and I have no idea what is even in any of my tax-advantaged / retirement accounts.

2. Social Security – An unfunded program; USA in the highest level of debt in history’ what’s the chances of Social Security being around in the same form when YOU retire?:

STRIKE 2 – When my social security statement arrives I chuck it in the trash without reading it, it’s irrelevant, it won’t be around when I retire, and I had this same line of thinking BEFORE I became rich.

3. Home Equity – Please! Where do you intend to live when you retire? By the time you buy and pay changeover costs etc. if you see any spare cash, it may be just about enough to pay off your remaining credit card debt:

STRIKE 3 – I live in my home equity, don’t you?

4. Pension Plan – Do you work for Ford/GM/Chrylser? Any airline? Just about any bank?:

STRIKE 4 [AJC: 4 strikes???!!! I’m an Aussie, what do I know from baseball?] Ditto to the above, in fact, I have never subscribed to an employer-sponsored pension plan, even where I have had the choice.

… need I go on?

The point is, if you know these tools aren’t going to work for you – as the majority of Americans surveyed by Gallup seem to – yet you keep using them – as the majority of Americans do – isn’t that the very definition of ‘insanity’?

Now, that’s a question that I would love to see the Gallup Survey for!?

Merry Chrismas?!

Why am I posting a really nice Christmas video on January 25th?!!

Well, it’s simply to make a point …

… it doesn’t matter how late you start, but how well you execute that counts.

Just ask Ray Kroc (McDonalds), ‘Colonel’ Sanders (KFC), my father (who started a business at the age of 60), and (hopefully, soon) our very own Lee Martin …. old is the new young 🙂

7Million7Years is One Year Old today!


Well, we’ve reached a Milestone … is officially ONE YEAR OLD … now, that’s a lot of posts! I hope that some have been useful?

To celebrate, I am running my first ever competition:

It’s easy, all you need to do is write your most pressing, interesting, or “I’m just plain curious” personal finance question in the Comments section below …

… I will choose at least one winner (maybe more, if I am blown away by the responses) and eventually publish answers to all of the rest.

The winner/s will receive a personal finance book of my choice (I may choose a book that I think will be relevant to their question, or one of my favorites … who knows?!).

So, don’t waste another moment: write your question in the Comments below (make sure that you signed in with your e-mail address, so that I can let you know if you’ve won … no need to include it with your answer, though).

A cracked pair of spectacles …

My ‘problem’ is that I seem to see everything as through a pair of glasses that somebody has stepped on – cracking the thick glass lenses, but not quite breaking them; case in point – Rick says:

Consider two cases in the first you rebalance in the second you don’t:


Stocks Bonds Total Comment
50K 50K 100K Initial conditions
25K 50K 75K right after market crash
37.5K 37.5K 75K After rebalancing
75K 37.5K 112.5K Right after market recovery
56.25K 56.25K 112.5K After rebalancing

No Rebalancing:

Stocks Bonds Total Comment
50K 50K 100K Initial conditions
25K 50K 75K right after market crash
50K 50K 100K Right after market recovery

Note rebalancing earned an extra $12.5K over doing nothing, it doesn’t compare to perfect market timing but there was no crystal ball required! Jeff pointed out rebalancing maintains the risk level. Was it less risky to hold half stocks half bonds? Yes, in the 50% market crash there was only 25K in losses rather than a 50K loss.

What if the order was different?

Stocks Bonds Total Comment
50K 50K 100K Initial conditions
75K 50K 125K Market rises 50%
62.5K 62.5K 125K Rebalance
31.25K 62.5K 93.75K Market drops 50%
46.9K 46.9K 125K Rebalance

No Rebalancing:
Stocks Bonds Total Comment
50K 50K 100K Initial conditions
75K 50K 125K Market rises 50%
37.5K 50K 87.5K Market drops 50%

Again rebalancing helps prevent losses over doing nothing. If you are invested in more than one asset class you should rebalance. We all know that there is no such thing as a free lunch though… What is the down side?

By allocating 50% bonds 50% stocks you only get half the superior stock returns if the market is steadily going up. Rebalancing reduces risk at the cost of returns in the good years. The good years actually do outnumber the bad, even though it doesn’t seem like it right now! If you can withstand the risk you should keep a large percentage in stocks. I’m young enough that I don’t have a large % of bonds- and it sucks to take the full losses. However, I’m willing to risk it now for the full gains and I’m glad I get to buy shares at a steep discount now. As I get older I will be increasing the % of bonds that I hold and will be rebalancing.

I ‘read’ the numbers, but I ‘see’ something totally different … something that Rick sees too, because he covers it in his closing comments:

The problem with ‘numbers’ is that they don’t reflect real life.

The market changes: it doesn’t reverse then recover with all ‘vital signs’ the same as they were before!

So, you are in constant ‘motion’ as bonds go up one day, stocks down the next (with sub-moves within the markets such that overseas funds are up and US funds down), and so on ….

Before we do any of this, we need to revisit our objective … why are we doing all of this in the first place?

You see, the key ‘number’ is in fact your Number and if moving half your net worth into Bonds to ‘avoid risk’ stops you from achieving your Number, why do it at all?

A simpler solution is to be 100% invested in stocks (or a suitable alternative) and hold for the long-term.

Warren Buffett is … George Soros is … I am [AJC: Well, almost 100% in real-estate with cash on the sidelines waiting for the next ‘deals’ to come along … although, I will also put some in stocks and ventures ‘for fun’].


When studies like the Dalbar Study show 11.9% 20 year returns, and others show absolutely NO 30 year periods EVER with less than an 8% compounded return in the stock market, why would you do anything else?

Of course, if your expertise is in real-estate, buying businesses, or Egyptian artifacts, I am sure that similar studies can show their benefits over 15 – 30 years, as well …

… the key is to find something that produces income that:

1. Tends to rise with inflation, and

2. You can leverage (borrow) to buy into

That way, if inflation is > 0% (as it surely will over 20 to 30 years), your return increases disproportionately (in YOUR favor, assuming that your income from the investment eventually covers your mortgage and other holding costs).

A closing note:

If rebalancing is the right thing to do, why is Warren Buffett – who was previously invested 100% in bonds – for the first time in 40+ years of investing, moving his entire personal net worth into the stock market right now?

The answer, of course, is simple: he sees that American Business is extremely undervalued right now … and, is happy to ‘rebalance’ his portfolio 100% away from bonds and 100% to stocks.

This is not really rebalancing at all: this is putting your money where the best value (hence, best long-term returns) are to be found.

A little off the top, please …

What do you do if, like ALL of the original 100+ serious applicants for my ‘grand experiment‘, your Number is in the millions?

That means that saving anything less than 50% of your salary over anything less than 20 years is unlikely to get you there?

As I mentioned in a previous post: in the world of money, the ‘momentum’ that we build up comes from the power of compounding; just take a look at how $1,000 compounds over 30 years (@ 10% p.a.represented by the blue part of the graph, below) … more importantly, look at what happens if we start just 10 years later (represented by the red part of the graph):


we can get to the same end point, but only by increasing our annual compound growth rate by  a hefty 55% (i.e. to 15.5% p.a.).

That difference in compound growth rates could literally ‘force’ you out of nice, safe, easy Index Funds into making scary, difficult investments in individual stocks.

Or, if your Number / Date combination is much Larger / Sooner, it may even ‘force’ you into investing in real-estate, small businesses/franchises, or even into starting your own high-growth businesses!

Which is fine for some …

So, you could just ‘go for it’ anyway … as I’ve said before massive passion drives massive action, which produces massive results …. maybe.

But, what if you’re the more rational (sane?) type? How do you come up with a more reasonable target?

I see two ways – and, I have posts for you to read on both of these … just follow the links, below:

1. Reduce your Number:

2. Extend your Date:

Seems obvious and easy, right?

Well, the ‘cost’ is in delaying and/or reducing your expectations for how you really want to live your Life … so, you want to consider ALL of your options, VERY carefully … fortunately, the financial-self-discovery process itself is not difficult ….

Food for thought?

The Risk / Happiness trade-off …

moneyhappinessThis kind of follows on from the Cash Cascade, which was a recent post about paying off debt:

Part of the decision-making process around paying down debt revolves around what you would choose to invest that money in, instead …

… and, that depends – at least in part – on your appetite for risk.

A while ago, I discussed the difference between what I call ‘technical risk’ and ‘absolute risk’ and Jeff (our resident ‘risk manager’) asks:

Ultimately, I just want to figure out how to calculate (take into consideration) the additional risk–or variance in outcome–that leveraging adds to an investment, so can make educated investment decisions.

It’s easy, Jeff: just attribute a risk % to each investment category based upon your perception of the various factors and multiply the expected return by that factor.

Or, you can try using the Standard deviation, and model thus:

r(V) = {V^2} – {V}^2 where curly braces represent average values. For compound returns:
r(V) = {N1^2}*{N2^2}*…*{Nn^2} – {N1}^2*{N2}^2*…*{Nn}^2

Now we can again use the definition {Ni^2} = v(Ni) + {Ni}^2 to get

r(V) = (r(N1) + {N1}^2)(v(N2) + {Nn}^2)…(v(Ni) + {Ni}^2) – {N1}^2*{N2}^2*…*{Nn}^2

Or, you can simply do what I suggest which is work backwards:

1. Decide WHY you need the money

2. Decide WHEN you need the money

3. Decide HOW MUCH money you need

4. Calculate the required Compound Growth Rate to go from where you are today to where you want to be

5. Decide if you can ‘stomach’ the inherent risks involved in the investment methods required to achieve that required compound growth rate

… if not, then go back to 1. and downgrade your expectations for happiness.