Debt
Debt: It's a wealth killer, a stress generator, and the chains that bind your future self.
I feel passionate about this topic, and for those who requested it, thank you. I do hope everyone will get something from this.
While we’ll touch on the numbers, I need to be clear: debt isn’t a math problem; it’s a behavior problem. I’m going to be direct, and my take on spending habits may ruffle some feathers. My goal isn’t to offend anyone, it’s to offer a clear, unvarnished perspective. Let’s get into it.
History
Looking back in history, the people of the United States were once commonly referred to simply as “Citizens” or “Americans”. In those days, if you were labeled a “Consumer,” it was meant to say that you were a person who squandered or wasted things (hmm).
Fast forward to roughly the mid-20th century, when we all stopped being citizens and became “Consumers”. The underlying message with this change in vernacular is that the people of the U.S. are viewed as less significant in the democratic process (not what you would expect from a concerned citizen or patriotic American). Instead, we are now seen as the essential components of the economic process, consuming goods and services. As such, we are constantly marketed to and manipulated into consuming more and more, and our ongoing consumption is monitored very closely to ensure the economic engine (you) stays on track, think Consumer Price Index (CPI), Personal Consumption Expenditures Price Index (PCEPI), Consumer Confidence Index (CCI), Consumer Spending, Consumer Credit, Consumer Leverage Ratio, etc.
We’ve been tricked into believing we’re entitled to buy whatever we want, often wasting money on things that provide little improvement to the quality of our lives. While American consumers are wealthier today than they have ever been, they are also lonelier and more depressed than they have ever been.
The Consumer Trap
Let’s examine a few examples of how we are enticed to consume and build our debt.
Buy now, pay later (BNPL) - Can’t afford this thing that you must have? No worries, we will give you a short-term loan so you can have it now.
This option is also available for the $5.00 burger being delivered to your house from Uber Eats!
Amazon Prime Day - Look how cheap everything is. You have one day (maybe it’s two now?) to buy it all.
Electronics - The new iPhone is out, you’d better throw away last year’s model and get in line to purchase the new one. Don’t worry if you are still paying for last year’s phone.
Credit Cards - Need a bank loan? It’s right there in your wallet to use anytime.
Auto loans (or worse, leases) - Let me talk to my manager and see what I can do. It doesn’t matter that your new car will depreciate 20% in the first year, just sign this six-year loan agreement.
Mortgage - Yes, a mortgage is debt too. Remember the housing crisis of 2008 that triggered the Great Recession? Consumers bought more house than they could afford and were unable to pay the lenders.
Student loans - If the debt of your education is greater than the expected first-year salary in your field of study, you might want to make some adjustments.
As long as you are in debt, you are working to earn money to pay the creditors. In other words, the creditors own your time, and you are working for them. The best way to get out of debt is to never get in. Control your spending habits, and live below your means. If you can’t afford it, you’re not entitled to it.
Know that your debt is someone else’s asset. It costs you freedom.
Know What You Owe
Never get in debt is fine for making my exaggerated point; however, very few of us are debt-free, and all of us have (or will) taken on some form of debt during our lives. So let’s examine some strategies to eliminate it.
Regardless of your strategy, the first step is to make it visible. You shouldn’t find yourself at the end of the month wondering where your money went. Make a detailed list of everyone you owe money to. I would use Excel, but paper and pencil are just fine.
List:
Creditor
Account number
Interest rate
Monthly payment
Due date
Total balance owed
Once they are all listed, total up the amount of money you owe. Not a fun exercise, but an essential step to making it all go away.
Now that we can see it, let’s examine some strategies to eliminate this debt. Spoiler Alert - there is no silver bullet. All these strategies require you to do the hard work and pay your debts.
Consolidation
I include this method just for completeness; however, I strongly advise against it. This area of finance is filled with predatory offers and false promises. It makes no sense to me to take out another loan to pay off all your existing ones. While it may simplify the picture, you’re left with existing credit cards at a zero balance, a tempting, open invitation to start using them again. You could end up digging a much deeper hole.
If you truly feel overwhelmed and don’t believe you can handle this on your own, go to the National Foundation for Credit Counseling and get trusted help (https://www.nfcc.org/).
Debt Avalanche
The debt avalanche approach focuses on paying off the loans with the highest interest rates first.
Arrange your list of debts from highest interest rate to lowest.
Use every additional dollar available to pay additional principal on the first debt on the list (i.e., the one with the highest interest rate).
Continue to make minimum payments on the others.
Pay off one and then attack the next debt on the list.
Mathematically speaking, this is probably the most efficient approach.
Debt Snowball
The debt snowball approach focuses on the loan with the lowest balance first.
Arrange your list of debts from the smallest balance to the largest balance.
Use every additional dollar available to pay additional principal on the smallest debt on the list.
Continue to make minimum payments on the others.
Pay off the smallest debt as quickly as possible and then roll that payment into your attack on the next smallest debt on the list.
This approach appeals to my personality. I feel a sense of accomplishment when I can check something off a list. I don’t want to potentially wait years before making the first checkmark. I also like the way it builds to making bigger and bigger steps as you progress. I think that is motivating.
The Fuel - Tighten Your Belt
The debt avalanche and the debt snowball both require you to pay the minimum amount on all your debts and make additional principal payments on one targeted debt at a time. Where does the money to pay extra principal come from? This points back to my earlier rant, you must manage your daily spending and reduce costs as much as possible. In some situations, it may be necessary to take on a side hustle and use that income to pay your debts.
If you spend every penny of your income, you have accumulated zero wealth. If you want to retire with a million dollars, you need to have a million dollars that you didn’t spend. I recently came across some great advice that suggests spending based on your net worth, not your income. Subtract your liabilities from your assets to determine your net worth. If your net worth is negative or zero, your current priority is not spending, it’s that side hustle!
Prices are going up, and cutting your spending will be challenging. I was recently notified that my cell phone and internet bills were being increased (no additional services, they are just going to cost more). I took a couple of simple steps that cut my cell phone bill in half and reduced my internet bill by $240 annually. Subscription fees can add up. It is important to monitor those closely.
If you are looking for help on where you can cut consumer costs, I recommend checking out https://clark.com/
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Mortgage - The Last Stand
There is no such thing as “good debt,” but many argue a mortgage is. I agree it will likely be the last debt on your list and take the longest to eliminate, and yes, you build [minimal] equity with each payment. But the debt itself is still a liability. The freedom of being retired with no debt has made a huge impact on our finances, allowing us to minimize withdrawals from our nest egg and enable longer, uninterrupted growth, in tax-deferred accounts.
When it is time to turn your attention to paying off mortgage debt, I recommend a two-pronged attack.
The first is to add some amount of additional principal payment each month when you make your mortgage payment. I remember when I started doing this with my first house, I was only able to add $100 a month. It barely moved the needle, but it was something. You can automate this through your lender’s website, where you can set an amount to add to your payment. Be sure to establish it as a principal curtailment and not an interest payment or advance payment on next month’s bill. Look to increase this amount when you get a raise or reduce some other expense.
The second prong of the attack is to establish a monthly sum to invest in some type of short-term security (e.g., money-market mutual fund, Treasury bills). The intent behind this fund is to build it up so you can make a large principal payment at regular intervals in the future.
I like the flexibility of this approach, as you are not obligated to use your savings in this fund for a mortgage payment. When you do, and you should regularly, it provides the opportunity to put a bigger dent in the mortgage principal. This does move the needle and can be very satisfying.
My approach with the savings fund was to assess it annually and make a decision based on the amount and what was going on in our lives at that time. It may take a little time to build up, but if you are disciplined, it will grow into a regular reduction of your mortgage principal. The key to making this successful is to ensure that the dollars saved remain focused on mortgage payments and don’t get used for some other discretionary purchase.
CRITICAL - The Debt Elimination Order of Operations
There is actually an order of operations here.
Establish a minimal emergency fund (e.g., $1,000).
Eliminate consumer debt (credit cards, auto loans, etc.).
Sure up your emergency fund (four to six months of living expenses).
Tackle mortgage debt.
Invest for your future (401(k), Roth IRA, taxable brokerage).
Continue to live below your means.
This is a generic list, and some of these items can happen in parallel. Everyone’s personal situation and goals will dictate priorities and the best-suited approach for them.
Conclusion
You must recognize the behavior that led to your debt in the first place. You can use the most efficient technique here to eliminate your debt, but if you do not modify your core behavior, you will end up right back in the hole. You are in control. Make informed and intentional choices with your money, and you will come out ahead. It is about personal choices and disciplined spending, regardless of how much money you make, that will make the difference.
I look forward to discussing investment options and strategies you can employ with the additional funds you have available once you are debt-free and living below your means.