The previous 2 parts of this blog focused on the decision on debt before you have taken it on. Many get confused by trying to use the same principles to decide how to treat debt they are already carrying. Whether it was a good idea or bad idea to take on the debt initially is not a factor in how to maintain it.
Once you have debt the decisions should be focused on what will give you the highest probability of meeting your goals. It is not uncommon today to find people that believe that their top priority is to pay off debt. This may be a good idea but as we see many times it is not always the best use of their assets.
Take the example of a person that is 60 and has 25 years left on a 4% home mortgage. At this age they have access to their retirement accounts, have other savings, and may have received inheritance. Is it a better use of their money to make a lump sum pay off of their mortgage and no longer have a monthly payment or keep the funds invested? Looking at history, the answer is to keep the funds invested.
If the person is in the 25% tax bracket and can deduct the mortgage interest then the net cost between the mortgage interest and taxes is in fact 3%. Over a 25 year period, history has shown that a diversified portfolio can return well in excess of 3%, allowing you to leverage the banks loan to allow your assets to last longer.
This methodology can be used for any current debt. High interest credit card debt is unlikely to be beaten by a reliable investment option and thus math tells us that paying it down provides a better likelihood of success than investing those funds.
At the end of the day, people want to accomplish their goals while sleeping well at night. Sleeping well at night is the one factor that throws a wrench in the math. It doesn’t matter how likely it is that you will increase your success if you haven’t come to grips with the decision and thus spend significant amount of time worrying about it. To determine what you should do with current debt, first do the math and determine what it recommends and then weigh it against how the decision will affect you emotionally.
-Marshall Rathmell-
