Debt sucks.
I’ve made it a general rule to avoid debt as much as possible. The only debt we carry is mortgage debt – on our primary residence as well as the 8 rental properties we own.
But even that debt (considered “good debt” by most people) is a burden. Every month we have to service all this debt. If one of our rental properties is vacant for a month we still have to pay the mortgage.
I know that I can’t quit my job or pursue early retirement until we eliminate this debt. These loans are a millstone around my neck, reducing my freedom and flexibility.
But here’s an even bigger issue – your debt is not only making you unhappy, it’s literally killing you.
The impact of debt
I recently saw this graphic in Money Magazine. It was part of an article about college costs and the impact of high student loan balances on recent college graduates.
As you can see, as student loan balances increased the graduates displayed a lower sense of purpose, lower satisfaction with their financial management, and perhaps most importantly, worse physical health.
I doubt the effect on physical health really surprises anybody. After all, debt is stressful and stress kills.
But what really saddens me is the lower sense of purpose exhibited by those with higher loan balances. My guess is that the need to pay off large student loan balances forces recent graduates into higher paying but less fulfilling jobs. A large student loan balance also precludes recent graduates from taking a year or two after graduation to travel, join the Peace Corps, or do other things that have low remuneration but might result in some serious soul-searching and self discovery.
I’m sure there are other negative effects from high debt that aren’t captured in this graphic. Debt is rough on relationships, and good relationships are one of the largest determining factors in happiness. It’s not much of a leap to assume that higher debt results in lower happiness.
And, of course, any money spent on debt repayment is money not saved and invested. Spending 5 years paying down debt means you have 5 fewer years of compounding to reach financial independence.
All of this leads to the natural question – what should you be doing with your money if you have debt?
The best use of your money today
First, let’s start with an observation – the stock market is ridiculously overvalued today.
Period.
The Schiller PE is about 75% higher than the long-term average. This means the market will have to drop by around 43% just to get back to the long-term average valuation.
Today’s high valuations mean that an investment made today will deliver far lower returns than the 8-10% that the market has averaged over the long-term.
When I’m deciding what to do with my money today I’m estimating that the market will return 3-5% per year for the next decade AT BEST. Given how extreme the valuation is today it’s entirely possible that returns will be lower.
So if the market is going to return just 3-5% over the next 10 years, what should we be doing with our money instead? I think the obvious answer is to pay down any debt that’s in the 3-5% interest rate or higher. This is all student loan, car loan, credit card debt, and almost certainly rental property mortgages.
It’s possible that your primary mortgage has an interest rate in the 3-4% range, in which case I can see an argument for not paying off the mortgage. Rental property debt is somewhat debatable as well, as your loan is probably in the 4-5% range but has the advantage of being fully deductible against any profits from your real estate holdings.
Reduce your debt today
Despite the above, I’d still recommend paying off all debt with any excess cash you have today. First, you’ll have greater peace of mind from having lower debt. After all, you can’t go bankrupt if you don’t owe anybody any money.
Second, you’ll free up significant cash flow by paying off loans. This additional cash flow will come in handy during the next recession.
What are your feelings on debt? Do you find that debt negatively impacts not only your finances but your health as well?
What are you doing with your money today? Are you paying down debt, building a cash reserve, or are you still regularly investing in the market?
I totally agree with you on the stock market but go back and forth whether to pay down the mortgages on my rental properties (half are paid off and half are not) so I decided to only do 15 year mortgages, which forces a somewhat higher payment and build cash reserves. Having cash on hand in 2009/2010 was well worth it!!
Did you buy your rental properties in the 2009/2010 timeframe, or did you load up on stocks?
I just remember being almost paralyzed with indecision on what to do because everything was so ridiculously cheap. Stocks were selling at insanely low valuations, people were throwing in time-shares and cars just so they could sell their real estate, etc.
I expect it won’t be long before we are able to put our cash reserves to work.
Avoiding debt is important to prevent additional problems but sometimes acquiring debt is necessary especially if you got into unforeseen emergency or you got into a situation where you need a large sum and you do not have enough available cash on hand. So the debt that you need is the one where can pay it on an installment basis. Some debt needs you to pay in full and this kind of debt is difficult because acquiring wholesome amount to pay is hard. So it is better to those who let you pay on an installment basis.