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Debt is bad! Why this statement is completely wrong! November 3, 2008

Posted by shaferfinancial in Uncategorized.
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I have found myself in the unenviable position of challenging a theory that not only has reached accepted truth among the masses of people, but is seemingly backed up by current events as well as biblical parables.  Probably, what perturbs me the most is the fact that those who perpetuate this myth should know better or do know better.  The destruction they bring down on people will be devastating, worse than any of the banks or financial companies that supposedly prey on people.

Here is a post placed on a blog which I will quote anonymously:
Who ever thinks he owns anything that is not paid in full needs to have his brains examined.
Every one is a small participant with the major holder the “lender”. Who is calling the shots.
Moral of the story. Plan to OWN something out right. Borrow in short terms, pay off your loan faaaaaaaaast. Forget the tax benefit hook. Be a captain of you own ship. Period.

And from Dave Ramsey, who I have much respect for:

Myth: Debt is a tool and should be used to help create prosperity.
Truth: Debt is not a tool; it is a method to make banks wealthy, not you.
Debt is dumb. Most normal people are just plain broke because they are in debt up to their eyeballs with no hope of help. If you're in debt then you're a slave, in the sense that you do not have the freedom to use your money to help change your family tree.

Now if you are using credit cards to buy things you can’t afford, of course this is foolish. It doesn’t take a rocket scientist to figure this out. Most people understand this. But the problem isn’t debt, it is spending. You have a spending problem and this is where Dave Ramsey does a real service, getting folks to admit their spending problem. But it has nothing to do with debt.

Now, some facts. Look behind every wealthy person and you will see at some time, usually early on in their wealth building they took on debt. Look at nearly every middle class person and you will see that they use debt, mortgage debt and household debt to purchase big ticket items like automobiles and trucks. Look behind the middle class wealth created and you will see home equity as the largest portion of wealth. How did this wealth get created? Debt, lots of it, a mortgage of at least 80% of the value of the home. And you know what, the vast majority of the middle class has never been forclosed on or gone into bankruptcy. The debt didn’t kill them, hurt them, or make them homeless. No, the only thing the debt did was to create wealth for them.

Ahh, but don’t we as a society have way to much credit card debt? No, 55% of Americans have no credit card debt. Of those who have debt, the median (half above and half below) is $2,200. Less than 9% of those with cc debt have over $9,000 in credit card debt and for this cohort over half have household incomes over $100,000. So there are perhaps as much as 3% who are in credit card purgatory. This is Ramsey and Orman’s real audience. These are the folks who ought to listen to them. Unfortunately, the other 97% of Americans are being subjected to bad advice based on that small minorities spending issues.

Take Ramsey’s and Orman’s advice; pay off all debt and invest in indexed mutual funds, and you are almost guaranteed to have a very frugal retirement, unless you are one of those folks with $250K household income. Let’s say you are making slightly above the median family income, $50,000 and you get your mortgage and all other debt paid off by the time you are 45 and you then save 25% of your income for the next 20 years at twice the average mutual fund investor return (8%). Congratulations, you have saved $618,000. Unfortunately, it is only worth $342,000 at that time because of inflation, which might give you $28,000 income from an annuity which is slightly more than half your present income.  Sound like a great retirement? And that is assuming saving 25% over 20 years, without a break, getting twice what the average investor in mutual funds get, average inflation of 3% and you don’t retire into a bear market and you are 100% invested in equities right up to the retirement date. Quite a lot of assumptions.

 

 

 

 

Think you might want to change the channel you are watching from Suzy Orman to something different?  I mean you might sleep well at night without any debt as long as you have income coming in the door, but how well do you sleep at night in your retirement when you know all you are getting in the door is barely enough to survive.  All the while taxes, food, insurance, gas, cable, electricity, etc. is marching upward as your meager retirement income stays the same?  Shouldn’t you think about how to keep that from happening to you now, while there is time to change?  Or, follow the no debt herd into a predictable predicament for which there is no way out?  You decide which channel you want to watch!

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Comments»

1. Evelyn Guzman - November 5, 2008

Yes, the statement that “debt is bad” is completely wrong for I believe in good debts. You mentioned the mortgage on a home that helped build the homeowner’s wealth. Then there is the college loan which is really an investment in the future of the college-bound. I categorize this as a good debt. I think it’s the way people handle debt that makes good debt bad like not paying on time, thus increasing one’s rate of interest. And in buying things that are not really necessary.

Evelyn Guzman
Debt Challenger

2. Pete - November 7, 2008

Buffet essentially used NO debt from day 1 and to this day will tell you there is no GOOD debt.

3. shaferfinancial - November 8, 2008

Sorry Pete, you are mistaken. Even today, with large cash reserves he is carrying $36+Billion in debt. Admittedly, this is a small amount of debt compared to the equity, but he has always used debt and the percentage was much higher in the early days. He also had this to say about the national debt: http://www.cnbc.com/id/26337276, surprising his hosts on a movie he made a brief cameo on. If he thinks there is no good debt, then why is he carrying $36B of it, when he could have paid it off with cash??

No doubt part of his fundamental analysis is looking at debt/equity ratio’s to make sure they are within certain limits, but he also owns stock in companies that have debt, some with substantial debt!

Warren Buffett understands the use of debt helps companies grow. He also knows that excessive debt can be dangerous if the servicing takes up too much of the cash flow. There is good use of debt, as Buffett recognizes.

Fortunately, for Buffett and those of us that invest in his company he knows how to use debt for his benefit!

4. Greg Finch - January 25, 2009

I am a firm believer in the fact that there are three forms of debt!
1) Bad Debt: this is any form of debt that I deem as a liability and not building toward an asset. Any form of revolving credit such as Credit cards certainly rate at the top of the list. This form of debt enslaves you to the financial institutions for life. This form of debt really takes your life and dreams away from you despite the fact that most people think the opposite.

2) Necessary debt: I describe necessary debt as money you need to borrow in order to either build future wealth or benefit from today. This would include student loans, automobiles for transportation or a home to live in verses paying rent. The key to this form of debt is to live within your means. There is no reason to impress your friends or family with the top of the line brand new car or a house that is much more than you need. You need to live within your comfort zone without burying yourself in debt. I am a firm believer that you should strive to pay off your necessary debt as soon as possible. By doing so you are creating your future wealth in assets no matter what the inflation or economy is doing.
3) Good debt: Yes there is definitely good debt out there! Good debt is simply the use of other peoples’ money that insures your success with a profit. Look at real estate as a example. There has never been a better time to purchase real estate. Home prices are at an all time low, interest rates are at an all time low and people needing to find a place to live is now becoming an all time high. This is the perfect scenario for someone looking to invest. You must be smart though. The key to any successful investment venture is cash flow. you MUST have a positive cash flow if you are to succeed. If you borrow $100,000 to purchase a piece of property with payments of $550 per month but can rent the place out for $1000 per month you have borrowed good debt while building your asset portfolio.

Each form of debt goes deeper than I have explained here. As with any financial decision , you should evaluate the pros and cons BEFORE making a move!


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