I have a sickness in that I like to read inordinate amounts of personal finance material. If you too are afflicted with this malady you have no doubt noticed the repetitive nature of some of the themes that us personal finance-types love. That’s because at its base, personal finance really isn’t all that complicated. If you make more than you spend, don’t buy stuff you don’t need, and have a clue about how to invest, you will probably do just fine. One of the all-time favourites of mine in the personal finance blogosphere is the high people get from paying down debt. While most people enjoy seeing their negative balances shoot into the positive range, personal finance-types experience a certain type of unique euphoria when this happens. Naturally, I think I’m probably influenced to some degree by all these articles that I read, so I am finding myself having to fight the urge to pay down my debt.
Why wouldn’t I just give in and join the kill-my-debt-as-fast-as-possible club? Because it just doesn’t make financial sense over the long run. Now before I explain why it doesn’t make sense in my personal situation to focus on paying down my debt, I want to make it perfectly clear that I in no way, shape, or form, suggest spending or investing if you have credit card debt, consumer debt, or basically any debt higher than about 7% interest. The ONLY time I would break that rule is if I had a quickly-growing personal business and was taking out an extremely short-term loan, or possibly if there were some great tax incentives in play. Other than that, consumer debt really sucks and is bad.
Forget About Debt! (Not Your Dad’s PF Message)
Ok, so now that we have made that clear, I want to explain why I am focusing on building our internet side business, as well as contributing to my TFSA, and RRSP accounts as opposed to putting every extra cent I can into my debt. My debts right now consist of a mortgage that is at a 3.6% interest rate (and is much smaller than most mortgages due to my geographical location), a $15,000 car loan at 2.9% (I know, I will burn in personal finance hell for this. It will probably be run by the CEOs of credit card companies), and a $10,000 personal loan at 4.9% that we are using purely to fund our business pursuits. I have no student loan debt, but if I did I would probably be ignoring that too (paying down a minimum). Surely with all these loans and the fact I rarely think about paying any of them down I am not fit to contribute to a personal finance blog you might be thinking. You might think that, but you would be wrong.
The Bogeyman of the PF World
The reason you would be wrong is that you have likely fallen into the all-too-common psychological trap of allowing your debt to control you. Remember that money is just a tool, and that owing money isn’t really a problem as long as you have assets that are growing every day. With the long investment time horizon that I have I am very comfortable with having 100% exposure in equities. As you are all probably fully aware of at this point, I am a huge fan of passive investing in the stock market. If I can attain merely average results in the stock market, minus a very small percentage in commissions and fees I should easily be able to hit an 8% rate of return. If you don’t believe the sky is falling, I think 9% is much more likely, and 10% is not as crazy as most people think (the average return of the stock market for the last 200+ years has been 10.4%), as long as you know that your money can be left alone for at least 20 years, but I’ll stick with 8% so I can keep my personal finance blogger card. If we agree that my money can earn 8% a year in a registered savings account, then by basic math any pay down of debt that is less than 8% is not a great investment.
Taking Into Consideration…
Now I realize it isn’t quite that simple. Interest rates can rise at any time, which can quite suddenly change the equation. Also, there is an argument to be made by the fact that when you pay down debt, that is an after-tax return on your investment, versus investment returns that might be taxed at a later date. Unfortunately I don’t have nearly the income yet to worry about maxing out my yearly registered savings plans, never mind taking advantage of all the previous years when I was in school and banked all of my contribution room. I won’t have to worry about tax rates affecting my investment returns for quite a while.
When we look at my specific debts we need to look at what they cost me right now, and what they might cost me in the long term. The simplest debt is my car debt (a decision I have yet to regret by the way), which is locked in at 2.99%. If stocks don’t return 2.99% over the next 20+ years then I will erase the entire database of this blog. My personal loan (which we are aggressively paying back with our side business income just so we have some liquidity), looks fairly high at 4.99%, but one has to take into account that the interest paid on that loan is fully tax-deductible since it was used purely to fund my business (it is considered an investment loan, and yes I have the paper trail to prove it). Therefore, it is a “real” interest rate of more like 3.7% or so. That debt is tied to prime rates, so it could rise, but at our current rate of paying it down, it should be gone before we see 2013, so I’m not all that concerned about it (one could make the argument we should forget about it and look for more assets to purchase actually). The most complicated debt is the mortgage debt. Obviously this debt has to take into account a much longer time frame. This means that it becomes extremely difficult to predict future interest rates. I am almost completely certain that prime rates will not rise more than .5% in the next two years, because our dollar simply couldn’t take that high a valuation versus the USD. After that, it is notoriously tough to predict interest rates, but since my mortgage only has about 84K left on it, I’m not overly worried.
What We Can Learn From Corporate America
When interest rates are this low and so many assets all around appear to be either undervalued, or modestly valued, good businesses take advantage and don’t hesitate to take out debt if it is advantageous. The principle of purchasing assets as opposed to paying down low-cost liabilities is applicable to personal finance as well as businesses. Now if you solely focus on getting out of debt as quickly as possible and trying to avoid it at all costs, you will probably be just fine in the long run, but you won’t have maximized your money/tool’s potential. The whole point of me knowing about money is to use the tool to increase my happiness in life. The best way to do that right now is to invest in assets that have an 8% return instead of paying down liabilities that would be equivalent to a 3-4% return. It really is that simple, no matter what your PF blogger-influenced conscience tells you!