Josh & Austin tackle the subject of debt in this week’s episode of The Invested Dads. They discuss what debt is in general, good versus bad debt, and paying off debt in financial planning. And of course, they have a good dad joke of the week that ends with a small discussion on music. Make sure to check out the link below if you want to invest with The Invested Dads!
Main Talking Points
[2:20] – Debt & Interest in general
[7:43] – Good Debt versus Bad Debt
[20:03] – Governments & Businesses in Debt
[23:40] – Dad Joke of the Week!
[25:15] – What To Do About Your Debt
[28:53] – Paying Off Debt
[31:10] – Debt & Financial Planning
[36:28] – Invest with us!
Links & Resources
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to the Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments, here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey, Hey, hey. Welcome back to the Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. Josh, we have pretty much the most exciting episode we’ve done, at least in the past week. What are we going to be talking about?
Josh Robb:
Yeah. Today, let’s talk about paying off debt. Debt is a scary four letter word in our industry, but in getting ready for this article or this podcast, I read an article and paying off debt has been around for a long time.
Austin Wilson:
How long?
Josh Robb:
It’s not something new. According to a HowStuffWorks article, which we’ll link in the show notes, paying off debt can be traced all the way back to the Mesopotamia era, which is about 8,000 BC.
Austin Wilson:
That’s a while back.
Josh Robb:
And they used clay tokens to track loaned sheep and wheat. If you loaned out your sheep or your wheat, then you had these tokens as a form of reminding that, “Hey, you owe me back something for that sheep or wheat.”
Austin Wilson:
That totally sounds like a settlers of Catan reference.
Josh Robb:
Yeah, it’s just crazy.
Austin Wilson:
Like your wheat and your sheep.
Josh Robb:
Yeah. Austin, when I say debt, what comes to your mind? What do you think of when the word debt is thrown out there?
Austin Wilson:
Yeah, there’s a lot of weird things that come to my mind a lot of the time but when I think of debt, I think of like owing someone something. Doesn’t necessarily have to be money. It can mean sheep. It can mean whatever but it’s about not having enough assets or whatever you need to fulfill your obligation that you have agreed upon and it’s typically not free. And in fact, I’d probably say it’s never free. There’s always a cost somewhat associated with debt and those costs are above and beyond the purchase price. And it’s called interest. Interest is the cost that you pay on top of what you owe for the lender because they’re really tying up their funds when they’re lending them to you. And they’re taking on the risk that if you don’t pay them back, there could be out the money. That is interest.
[2:20] Debt & Interest in general
Josh Robb:
Okay. I am interested in learning more about this. Tell me … Walk me through this. Breakdown pieces of debt and interest in general.
Austin Wilson:
Well, first of all, I see what you did there. That was a punny pun but there’s really a couple areas, when you think about interest, that I think about when and as it relates to debt and those are interest rates. That’s part one. And part two is collateral. We’ll talk about rates first. Rates can really be broken down to a couple of different categories. Fixed rate interest is really where the interest rate is fixed. That percentage of extra you’re paying to the lender, is fixed throughout the lifetime of the loan. There’s also a variable rate interest and these can fluctuate over time, generally in the direction that the overall interest rate environment is moving. And there’s often a period where it’s locked in, usually at the beginning or whatever, when you think of something like an adjustable rate mortgage or whatever.
Josh Robb:
Mortgage is a good example of both.
Austin Wilson:
Yes.
Josh Robb:
You could get a fixed mortgage. You say, “I have a 3% mortgage for 15 years. And so every year, I’m getting this 3% interest rate charged on the loan of the money. Yes, I pay it off. The loan balance goes down but I’m still paying the same interest rate the whole time.”
Austin Wilson:
Correct.
Josh Robb:
And then there’s a variable where it’s called an adjustable rate mortgage, but it starts out maybe at a lower interest rate. Maybe it’s 2.2% or something but after five years, it adjusts to whatever the current interest rate is.
Austin Wilson:
Yes.
Josh Robb:
And then for the rest of the life of that loan, then I have a higher interest rate.
Austin Wilson:
And I think that a lot of credit card rates and stuff are adjustable rates and they can float up and down and stuff like that but we’ll talk a little bit more about credit cards later. The second part that I mentioned was collateral. When you’re looking at debt, you can have debt that is collateralized, meaning that there is a hard asset. A hard asset is a house or a car or something tangible and as a hard asset, the lender can come back and take if you’re unwilling or unable to make your payments. You’ll find the rates on these collateralized loans are typically lower because like I said, there’s less risk when the lender can come back and take those assets from you.
Also noteworthy, depreciation treats homes and vehicles differently. That’s why you’ll see difference in rates between the two. Homes typically go up in value over time, so rates can be really low because the risk is lower for the lender but vehicles on the other hand, depreciate the second you drive them off the lot and get become less valuable over time. Interest rates may be higher to cover the risk that the lender’s taking that’s increased. Little fun fact there. The second …
Josh Robb:
Going into that real quick, Austin.
Austin Wilson:
Yeah.
Josh Robb:
I think for a lot of people don’t understand, that’s why there’s different interest rates for different things, is, “Why is my home rate different?”
It’s because whoever’s lending out the money wants to be sure they have a high probability of getting that back.
Austin Wilson:
Yeah.
Josh Robb:
And if they don’t have a high probability, they want to be compensated for that with something that will give them something to help out offset those cost.
Austin Wilson:
Right. Generally …
Josh Robb:
If something’s going to decrease in value, I’m going to want higher interest rate because there’s a chance that 10 years from now, that’s going to be worth less than if I have to take it as collateral. I may not get all that I lended you out of that.
Austin Wilson:
Exactly. And even when you think about corporate or municipal bonds or any bond really, the more risky it is, the less likely that the government or the municipality or the corporation is going to be to make those payments, the higher the interest rate’s going to be to the consumer or the investor who’s holding that because the risk is higher.
Josh Robb:
Yeah.
Austin Wilson:
Risk and interest rates have a direct correlation. They move in the same direction. The other half of that is unsecured debt. Unsecured debt is where things get a little hairy. It’s when you don’t have that hard asset backing the debt. The risk is higher for lenders. They can’t go back on things and it makes them charge higher interest rates for that increased …
Josh Robb:
I thought it was a debt that just wasn’t confident in their ability. That would be insecure debt but unsecured debt is where it’s not…
Austin Wilson:
Yes.
Josh Robb:
I guess.
Austin Wilson:
Debt insecurity. I should add that for next time. Believe it or not, student loans are actually an unsecured debt. There’s no hard assets that a lender specifically, whether that be the federal government or private loans or whatever, can go back on and take away from you if you stop making payments. And that is a controversial topic but that is the explanation of why student loan interest is higher than say, a car or a house. It’s a lot higher than those.
Josh Robb:
Which is also why a lot of times they want a co-signer, like your parents or somebody because they want more people to have the obligation to pay that back.
Austin Wilson:
Exactly, yep.
Josh Robb:
If the first person isn’t able to.
Austin Wilson:
Some other examples of unsecured debt is credit cards because you can put whatever you want on a credit card and they’re not going to go through and say exactly what you bought from where you bought it and then go take it from you. That’s why the interest rates are extremely high on credit cards. Personal loans are similar. Yeah, it’s very, very interesting. And it’s all about risk, whether it is through collateral or not having collateral, it’s just about the risk that the lender is willing to take and they’re going to be compensated through higher or lower rates.
[7:43] – Good Debt versus Bad Debt
Josh Robb:
Yep. All right. That helps explain debt in general, the pieces within paying off debt. You have an obligation or owing. Now, there’s two different categories of debt in my mind. There’s good debt and there’s bad debt. Good debt is anything that, in my opinion, is tied to an asset, like you said, that is growing in value or it’s tied to something that’s going to provide greater income for you in the future.
Austin Wilson:
Right.
Josh Robb:
And the opposite of that would be bad debt, which is tied to an asset that’s losing value or it’s debt that hinders your ability for income. What are some good debts and some bad debts? Yeah, an example in my mind of good debt, you mentioned one already. In my mind, student loan debt is a form of good debt because a college education increases your ability. Now, if you have the right major, sometimes you could choose a major maybe that doesn’t help you have more debt than what you’re going to get out of it but in general, when you leave college, you’re more employable at a higher wage.
Austin Wilson:
Right.
Josh Robb:
That debt provided you with a higher income stream in the future. Of paying off debts, when you’re looking across the board, that is one that would be more on the good side of things.
Austin Wilson:
Probably to a point.
Josh Robb:
Yes.
Austin Wilson:
There’s probably to a point in all of these things.
Josh Robb:
Yes. Yep. And then another one, again, you mentioned a home normally over the long run, increases in value. A debt tied to that asset. The asset is increasing, which makes the percent of that debt owed get smaller, smaller over time. Again, to some extent you don’t want to be … Which we saw in ’08 or 9, people were over leveraged in their mortgages, which caused a lot of problems but in general, that is a type of debt that is not necessarily a bad debt.
Austin Wilson:
Right. Speaking of bad debt, some examples of bad debt, things like depreciating assets, like auto loans typically frowned upon. Sometimes things happen. We understand that but when you’re taking on debt and paying extra on top of what you’re already … Of the cost of the item, on something that is decreasing in value, you’re just digging a hole.
Josh Robb:
Here’s a real life scenario I want to get your opinion on, Austin.
Austin Wilson:
Uh, oh.
Josh Robb:
Real life. Happened to me. Years ago, I was looking to buy a used car. And when I went to the car lot, found one I liked, they also had a new brand new car. It was a different model, little bit smaller but they were offering 0% financing.
Austin Wilson:
0%.
Josh Robb:
0% financing …
Austin Wilson:
For how long?
Josh Robb:
It was … I forget but in a sense, I had the cash to pay for it.
Austin Wilson:
Yeah.
Josh Robb:
Because it was in the same price range as the used car I was looking for. I was going to pay cash for that used car. I ended up getting the newer car and I did the 0% financing, put the money in a bank account and just had it automatically each month pay it off.
Austin Wilson:
Yeah.
Josh Robb:
Is that good debt? Is that bad debt? Is that even debt?
Austin Wilson:
That is a great … That’s really a conundrum. I don’t even really know how to explain that. I would probably have done the same thing because even … Say, for example, put some numbers on the table. Say it’s a $20,000 car and you have $20,000 you can go buy a car for. And you can pay cash for tomorrow. Or you could pay $400 a month for … I don’t know, four years or whatever it is for that car, as 0% interest. Well, that money is worth more in your pocket today than to be able to do what you need to do with, to be able to fund other purchases, to be able to invest, should be able to put an emergency account together, whatever, than it would have been to drop it all at once. Now, if you have all of those things covered, yeah. Some people are in the position where it doesn’t matter.
Josh Robb:
Yeah.
Austin Wilson:
But people who actually need paychecks every single month to live, that could be a lever to pull if that’s an available option. And I think a lot of things look like that right now because we live in a land of zero interest almost, on … Lending is so cheap right now. You can borrow money for nothing almost. Mortgages are two to 4%, depending on what you’re looking at, fixed rate, 15 to 30 years, whatever. That’s just dirt cheap historically. And everything else is really, really low as well. Especially, at the time we’re recording this, the federal reserve has not too long ago, cut interest rates back to zero for the first time since they came out of the great recession. We’re going to have low interest rates for a little while because there’s still a lot of uncertainty and that’s going to make borrowing costs cheap across the board, cheaper relative to what they would have been.
Josh Robb:
Yeah. And I think you’re going to see a lot of people and companies taking advantage of that when comparing the options to, “What do I pay in the debt, as opposed to my other assets and the other obligations that I have?”
If the debt is cheap, a lot of times that makes a better deal than maybe raising equity, different ways …
Austin Wilson:
Exactly.
Josh Robb:
For funding the business.
Austin Wilson:
And if you look at specifically corporations, they often are compared on their weighted average cost of capital, WACC. And that is a component that takes the cost of their debt financing … If they were to issue debt or bonds to fund operations or projects or whatever and then the weighting of that in proportion of their total capital requirements, compared to the weighting of if they were to issue stock, the same thing. And stock typically has a higher required return for investors. Right now, when companies can issue debt really, really cheap, their total average cost of capital is coming down and that’s helping the valuation on projects and expenditures look a lot more favorable than it would have been even a year ago.
Josh Robb:
Yeah. Whenever I see that formula written down, by the way …
Austin Wilson:
Yeah.
Josh Robb:
I have to say, that formula is whack.
Austin Wilson:
That formula is … It’s whack.
Josh Robb:
And no one laughs at it but I say it every time I see it written down.
Austin Wilson:
Josh, I will laugh at your whack joke.
Josh Robb:
I’ll message you each time I see it.
Austin Wilson:
Another thing, a good debt … Speaking of good debt, I think it’s probably … In some instances, if it’s done properly, considered good debt to take out a loan to start a business. If you’ve got a solid business plan and you’ve got some cash on the side to fund … If you need that cash right away. If you are convinced that the cash flows are going to exceed your debt payments easily, then you should be in pretty good position.
And that could be a good use, like you said earlier, of taking on debt to increase your income or to be your income, if you’re starting a business. Also, it’s real estate investments. A lot of people take out loans to buy a house, to rent out to people. As long as their rent payment’s net of their expenses that they have to keep place up and put them in the positive, then that’s a good use of debt. I think that those are some other examples of good debt but for both of those cases specifically, it is very, very wise to have a good and solid emergency fund on the side, just to be sure that if something like COVID-19 happens and you’ve got to stop collecting rent or you’ve got to operating your business, that you’ve got your cover, you’ve got yourself covered on your expenses.
Josh Robb:
Yeah because we saw a lot of that in the news, where landlords who own properties were getting worried that they would be unable to pay their obligations to the bank because their renters were unable to pay them.
Austin Wilson:
Right.
Josh Robb:
And so yeah, if you are looking to do a venture like that, where there’s a lot of risk involved, increasing that emergency fund, making sure you have a little bit more safeguard for your finances, is very prudent thing to do.
Austin Wilson:
And I did see even today … Just for reference, we’re recording this on May 8th, 2020. I think today, I saw that 10 million Americans in the month of April elected or did not pay their mortgage payment, so there’s a reality in this interesting and difficult and horrible situation we’re in economically. That’s a tough thing but that’s … These are examples. These situations, this one is different than anyone ever but there are situations where it’s wise to just be smart and have some money set aside. And we should probably have a full episode dedicated to an emergency fund and how you can build it up and what that can be used for but that is … That’s really good.
[16:01] – Margin Loans: Good or bad debt?
Austin Wilson:
Oh and another thing. You want to know a debt that could be good or bad.
Josh Robb:
Yes.
Austin Wilson:
Margin loans.
Josh Robb:
Margin loans. That’s the not butter alternative, your …
Austin Wilson:
That’s so gross. Do you like margarine?
Josh Robb:
Yeah. I think … Yeah. Is that vegetable spread? Yeah, it’s …
Austin Wilson:
Are you serious?
Josh Robb:
The next best thing. It’s awesome.
Austin Wilson:
I don’t know if you’re skidding or if you’re serious.
Josh Robb:
We do use it actually, yeah. It’s easier to spread.
Austin Wilson:
That’s so gross, dude. I’m a butter for life guy. If it says light on it or substitute of something fattening, I don’t need it.
Josh Robb:
No, just…
Austin Wilson:
But anyway, margin loans, not margarine.
Josh Robb:
Okay.
Austin Wilson:
Margin loans. Literally borrowing money to invest, right. Sounds sketchy.
Josh Robb:
Risky.
Austin Wilson:
And sounds risky. Yeah, you’re exactly right. And for most people, I would say it probably is unwise, in general. I would say that there are some people who are very, very good traders who can take that money and they can … They put in X amount of dollars and they can invest more than that. The ratios and the percentages are totally different for everyone or whatever but that’s the general philosophy. You put in $10,000, you can invest 20. And if your amount of the total value of your investments gets down to a certain threshold, they’ll ask you for more money to bring you up. It’s called a margin call. That is something, that is … If done properly, a potentially good tool but for most investors, it’s not wise because there’s a lot of risk associated with that. And that’s also why it’s probably good to work with a financial advisor because hopefully they would try and talk you out of that, unless you’re like a professional trader.
Josh Robb:
Yeah. And honestly, we’ve had those conversations with clients where they’ve said … And this happens a lot in really good years, so a 2013 or 2019, where the stock market’s just up 30% or more and things are going great. You’ll have a client say, “Hey, I have this equity line of credit with my home. Should I take that out?”
And this is different than margin but the same concept, “Should I borrow that money on credit and use it to invest because everything’s going so good? I could probably earn more than my payments are for that loan.”
Same idea of margins but it’s a concept of, “Hey, if I could get more money in and grow it, this is great.”
Austin Wilson:
Right. I would say specifically in those times, specifically last year, that’s a tough one because it’s … You have FOMO when things … Fear of missing out, when things are going up, up, up, up, up, up and you’re willing to get too risky, leverage yourself out, when that’s actually the time you should not.
Josh Robb:
Yes.
Austin Wilson:
Historically speaking.
Josh Robb:
But again, going back, that’s why you need a financial advisor, is there is historically just recorded evidence that people tend to chase performance, chase returns and then react emotionally when the markets change. And so those two things really hurt performance, long-term and a good financial advisor can help you alleviate a lot of that emotional decision making where you’re … The fear of missing out, chasing performance, saying, “Man, I hear my neighbors saying this and that. I need to make sure I’m trying to do all I can to catch back up.”
And you make those decisions that when you have time to think back on it, you’re like, “Why was I even considering that?”
Austin Wilson:
Yeah. And margin was actually a pretty sizable factor in the stock market crash in 1929, that was record. That is another reason to just be cautious. Josh, I want you to repeat after me, “I, Josh Robb.”
Josh Robb:
I, Josh Robb.
Austin Wilson:
I’m not Josh Robb, you’re Josh Robb. I, Josh Robb, promise …
Josh Robb:
Promise.
Austin Wilson:
To listen to Austin.
Josh Robb:
To always listen to Austin.
Austin Wilson:
When he says that he is not advocating for margin loans.
Josh Robb:
That he is not advocating for margin loans.
Austin Wilson:
That’s right. Thank you.
Josh Robb:
Don’t listen to Austin. Ever.
Austin Wilson:
Don’t listen to Austin.
Josh Robb:
Is that what I was promising? No. [inaudible 00:20:00].
Austin Wilson:
No margin loans. I’m not advocating for that people.
Josh Robb:
Right.
[20:03] – Governments & Businesses in Debt
Austin Wilson:
Okay. Side note, just like you and me, I think I mentioned this earlier, businesses and even governments constantly weighing the pros and cons of different financing options and whether they should finance expenses or investments with debt. Like we talked about earlier, there’s bonds out there. Bonds are really IOUs from corporations or governments where you’re going to lend them your money. And they’re going to give you a fixed percentage of interest and then your money back at the end over time. And the more risky it is, the higher the interest rate. Whether that’s a more risky company or a more risky or less sure government around the world or whatever that is, so not just consumers can have debt but businesses and governments can have debt too. And we’re in the most indebted country, probably in the world. It just happens. That’s just one … That’s a whole other side of debt in general but consumers aren’t the only ones paying off debt.
Josh Robb:
Yeah. And speaking of …
Austin Wilson:
And that is something that we should have a full episode on in the future, is bonds and fixed income in general because the fixed income market, fun fact, it’s bigger around the world than the equity market around the world.
Josh Robb:
By quite a bit.
Austin Wilson:
Exactly. Everyone’s been so … Not everyone but a lot of people and even myself, tend to focus on equity markets and equity market performance. And that is great. And historically over time, equities have done very, very well but the market size is huge.
Josh Robb:
Yeah.
Austin Wilson:
That is a plug for a future episode for fixed income and bonds.
Josh Robb:
In speaking, you’re mentioning the overall debt that our country has and municipalities and that but when we look at household debt here in the US, one of the positive though, that has come out of what we’ve seen in recent years, is the average household debt is lower than it’s ever been. In fact, when we look at the amount they pay for their debts as a percentage of their income, how much of my paycheck that comes in goes to paying off debt such as those, it’s at all time lows, all the way going back to the 80s. We’ve never been this low on our percent of payment.
Austin Wilson:
What about in dollars.
Josh Robb:
In dollar terms, debts costs can be higher. Debt is higher in dollar terms.
Austin Wilson:
Yeah. I was just … I was plugging that. It’s so interesting.
Josh Robb:
Yes. Oh, yeah.
Austin Wilson:
You look at it in dollars or you look at it in percent because people make a lot more money today than they did at the other comparison periods. Their debt level can be higher in dollars and still be lower in percentage.
Josh Robb:
Or even a whole.
Austin Wilson:
But that’s the thing, is that while everyone was crazy leveraged to debt in ’08 specifically, they’re making more money now. And maybe they have the same amount of debt or whatever but they’re making more money, so their debt payments as a percent of their income, is a lot lower.
Josh Robb:
Yep.
Austin Wilson:
There are a lot …
Josh Robb:
Just think about what it costs to buy a home now as what a home cost 40 years ago.
Austin Wilson:
Yeah.
Josh Robb:
It’s a lot higher. Does that mean there’s a lot more debt out there? Well, incomes have also gone up as well.
Austin Wilson:
Right.
Josh Robb:
Again, you’re right. And so what we actually saw is, the average household debt is actually below 10% of their disposable income, is going towards debt now, which was all the way all above 13% back in 2007, right before the last big drop and the recession.
Austin Wilson:
That’s probably excluding mortgages, right.
Josh Robb:
Yeah. That’s disposable debt for disposable income, yep.
Austin Wilson:
Got you. Yeah.
Josh Robb:
Yeah. And again, it’s looking at the different types of assets.
[23:40] – Dad Joke of the Week
Austin Wilson:
All right. Let’s do dad joke of the week.
Josh Robb:
Oh, I’ve been waiting all week for this.
Austin Wilson:
Okay.
Josh Robb:
Right, I actually got two for ya and they’re debt related. All right. Here’s the first one. I almost, almost took out a loan last night. It was a near debt experience.
Austin Wilson:
Near debt.
Josh Robb:
All right. And Austin, you’re going to love this one. All right. I finally paid off all of my debt. I’m debt free now. To celebrate, I went to a concert. Guess whose concert I went to?
Austin Wilson:
I’m trying to come up with a witty answer. I don’t know.
Josh Robb:
Post Malone, post my loan.
Austin Wilson:
Post my loan.
Josh Robb:
Post Malone.
Austin Wilson:
See, okay. Speaking of post Malone …
Josh Robb:
Speaking of him.
Austin Wilson:
I’m so out of modern music that I hardly know who he is but I know that he’s into like rap, R&B kind of thing, right. He has all the tattoos.
Josh Robb:
He has tattoos. I know that.
Austin Wilson:
But he is actually a really good guitar player and musician and singer, outside of that genre and yesterday or this morning, I don’t remember. I watched a YouTube video of him covering a Nirvana song with his band. And it was awesome. So Post Malone.
Josh Robb:
Yeah. Sometimes when you see him in just one genre, you don’t realize some of the other talents.
Austin Wilson:
I know, there’s just some of them … Some of those people are just talented musicians, period. They just happen to be performing in a certain genre.
Josh Robb:
Yeah, craziness. Confession, I don’t know a single Post Malone song.
Austin Wilson:
I don’t either. I just know that he covered a Nirvana song.
[25:15] – What To Do About Your Debt
Josh Robb:
There we go. All right. Back to debt. We talked about debts and which types we think are better than others. Now, let’s get in … Most people will say, “I have some debt.”
If you own a home, most people have a mortgage on that home. You may have some credit card debt, student loan debt, there’s debt out there. Like we said, the average person has a percentage of their disposable income that’s going towards all those different types of debt. Most people, their objective is to get that debt paid off at some point. And we always encourage people heading into retirement, that to get rid of debt is a lot less stressful in retirement because while I have income coming in, it’s easier to look at that debt and say, “Okay, I’m paying for those costs, my mortgage payment, whatever it is. I have the funds needed every month to pay that down. In retirement, I’m relying on all my investments and everything I’ve accumulated.”
Josh Robb:
Having an obligation to somebody can be a lot more stressful than while you’re working.
Austin Wilson:
Right.
Josh Robb:
A lot of people’s goal is to be debt free heading into retirement. All right. We’re going to look at some ways of paying off debt. There’s a couple of things that we hear a lot. One of the first questions is, “Should I pull my money out of my 401(k) or some of my investments to pay off the debt?”
We get that a lot. Austin, what do you think?
Austin Wilson:
I think that that is a very … Yeah, that’s a common question. And I think that to answer it, I would probably say it’s different for every situation.
Josh Robb:
That is the correct answer.
Austin Wilson:
I’m going to pull in … I’m going to channel my inner Josh Robb.
Josh Robb:
Yep.
Austin Wilson:
I’m going to say, “Let’s just put this up to moderation.”
Josh Robb:
Moderation.
Austin Wilson:
And I think … Because that’s saying you could probably do a little but I understand the mental aspect of, “I don’t want to have these debts hanging over me when I have … I have to be very strict on my financial plan to make sure it works out, so that I have enough money to live on the rest of my life.”
I understand that but the reality is … And especially in 2020 with interest rates being very, very, very, very low and specifically talking about mortgages, you are borrowing money at three to 4%, maybe less, who knows, for your house. And that three to 4% is a lot lower than it used to be, to have a mortgage. And your money in the market … Now, take out crazy things like we saw in the first quarter of 2020 but in a normal stock market environment or say you’re in a 60/40 portfolio with stocks and bonds, you’re going to get 6, 8, 10% potential over a long term.
Josh Robb:
Yep.
Austin Wilson:
And that is greater than the cost that you’re holding, to pay your mortgage, to have that mortgage. It’s different for everyone. Some people just want to do it for the peace of mind and it allows them a lot of flexibility.
Josh Robb:
Yep.
Austin Wilson:
But the tension that I think that we all have to think about is, “Do you want the peace of mind? Or do you want the mathematical? It’s going to save you $1,300 a year.”
Or whatever, who knows but there are two different ways to look at it, “Do you want the peace of mind or do you want the mathematical right answer, that’s proven to be correct?”
Josh Robb:
And I’ve found in working with clients, the emotional side of finance is a lot of times more important or more impactful than sheer numbers.
Austin Wilson:
Yeah.
[28:53] – Paying Off Debt
Josh Robb:
I can show them and show them right on paper, like you said, “Here’s how many dollars difference there is potential.”
But the psychological side of things over-weighs a lot of the rational of numbers. And so you always have to factor that in. And that gets us to this next thing, is, “Okay. I have debt.”
There’s ways out there of paying it off. There’s two big ways in general. And I still believe these were developed probably out West in Colorado because they’re both snow related. Someone was up on skiing and thought, “Here’s two ways to pay off debt.”
There’s the snowball method. And snowball method being you start with the smallest balance and work your way up. You’ll list all your debts that are owed and you take the smallest balance first and go from there. Everything else you pay the minimum on and all the extra money goes towards the smallest balance. The reason it’s snowball, is if you roll a snowball down a hill, it grows bigger and bigger as it goes because it’s collecting snow along the way.
Austin Wilson:
I see that in the movies but I have yet to do that in real life.
Josh Robb:
It’s cool when it happens. At bottom of the hill and then you get squished.
Austin Wilson:
There’s no hills in Finley.
Josh Robb:
No but the idea there though is, as each of those debts are paid off, you take then that … All that money was going through that debt, move it to the next one. It does compound and grow as each debt has more money heading towards it because there’s less owed to other debts and it’s added to that one. In fact, in 2012 there was a study by Northwestern’s Kellogg school of management, who found that consumers who tackled the smallest balance first and then work their way up, are more likelier to eliminate their overall debt than trying to go the other method, which is the avalanche method, which is where you list them from highest interest rate down to lowest interest rate. And the reason why you do that is … Again, going back to just straight on paper, “The sooner I can knock out those high interest rates, the less I’m paying in interest. I have less overall costs when I’m all done.”
Austin Wilson:
Right.
Josh Robb:
This study found that people actually stick to the smaller balance to larger balance method, even though they’re going to pay more in the long run.
Austin Wilson:
Because it feels good, right.
Josh Robb:
It does. And you get wins sooner.
Austin Wilson:
Right.
Josh Robb:
Because you’re tackling the smallest ones first, so that you’re sooner to see progress.
Austin Wilson:
And you’re encouraged, right.
Josh Robb:
What’s that?
Austin Wilson:
You’re encouraged to keep going.
Josh Robb:
Oh, yeah.
Austin Wilson:
You cross one off the list. You’re like, “Oh, that feels good. I can do it again.”
Josh Robb:
Yep.
[31:10] – Debt & Financial Planning
Austin Wilson:
Cross another one off, cross another one off. And yeah, it’s all in your head but it is a very powerful tool, so I guess the question Josh, putting you on the spot right now.
Josh Robb:
Oh, boy.
Austin Wilson:
Which one’s better?
Josh Robb:
Which one is better? If you’re asking me as a financial planner, I’m actually leaning towards the snowball method. Coming back to that finance being a psychological behavior.
Austin Wilson:
Behavioral and psychological. Yeah.
Josh Robb:
Behavioral finance is huge. And so if I know there’s a higher probability of a client succeeding in paying down those debts, if that’s their goal, then that method, although they may end up paying a little more interest or it may take a couple more months, that alone gives them a higher chance of success. That’s the one I like. Now, there is … moneyunder30.com has an article on that. We’ll link it in the show notes. They actually show you those two options in a scenario and compare it. And it’s not a big deal. In their scenario, they show it’s only a month or two difference and a couple hundred dollars in the long run. Again, it’s not like it’s huge that, “Oh, man. Look at all this extra money I’m giving up on, just to have a higher chance of success.” No but it does make … It does matter.
Austin Wilson:
Right.
Josh Robb:
And again, coming back to it is, I like the method that gets it done.
Austin Wilson:
Yeah.
Josh Robb:
Even if it takes a little more.
Austin Wilson:
Now, you probably say that different … You would advise different clients, different ways if you knew them and how they’re extremely type A.
Josh Robb:
Yeah. Then they may just put it on a sheet and they’re going to stick to that. If they’re very goal oriented too, where if they just have an objective and they will get there, avalanche method is great because you’re going to knock those out and save some money but you got to know they’re going to stick with that plan because it may take them longer to get that first win than the other way. And you don’t want them to give up or get frustrated.
Austin Wilson:
Right. Josh, any other big picture thoughts on debt as it relates to someone’s financial plan and their financial situation.
Josh Robb:
Yeah. I think debt can take a lot of focus away from the longterm goals. You could be so focused on knocking out your debt now and putting all your effort towards that, that you could miss out on the compounding of investments for the longterm goals. And so going back to what you said about moderation, is there’s a balance that needs to be put in place between short term goals and longterm goals. And make sure both are being adequately adjusted for and compensated for your current situation because if I’m drowning in debt and I can’t even get through the end of the month without running out of money, then yeah, you need to focus on that but if you’re the average person who says, “I have debt but by the end of the month, I’m fine. I’m also adding a little bit to my 401k.”
You need to balance those two because the time, every year, wasted on not investing that money, misses out on the ability to compound in the long run.
Austin Wilson:
Right.
Josh Robb:
Every year you wait is a lot of lost opportunity in the long run. And so in my mind, as little debt as possible is great. I’m a big proponent of, “Have little to no debt.”
Austin Wilson:
Right.
Josh Robb:
But when comparing to some of your other goals, I’ve seen people make the mistake of focusing too hard on that. And then 20 years down the road, when they’re getting ready to retire, they’re trying to play catch up. And the cost of that catch-up … The things they have to sacrifice or the amount they have to put in to catch back up to where they would be, is very detrimental to their lifestyle and their enjoyment because …
Austin Wilson:
Well, that’s just it. I feel like some people take it … Maybe it’s not technically too far but it’s further than I would go. And they’re very extreme on it. They won’t take a family vacation until they get their house paid off or whatever. And I’m sitting here and I’m like, “Yeah, I have a mortgage but I’m not going to not enjoy taking a vacation with my family this year, just so I could pay an extra payment or whatever on my mortgage.”
There’s a balance. And like you said, it’s moderation over time and that’s going to compound in both ways.
Josh Robb:
Yeah. And it comes to the unknown, is there’s things that you can’t get back, like you talked about with your family. Your kids are only young once. Invested Dads, it comes back to the family lifestyle as well.
Austin Wilson:
Yeah.
Josh Robb:
My kids are only this age once and there’s only things there’s all these things they’re going to enjoy now, that if I don’t take advantage of it, there could be regret down the road. Even if I have more money because I postpone those things, what good is that money if there is nothing that I can enjoy with my family with that? And so you’re right, there’s a balance to be had. And I encourage everybody out there, if you’re struggling with debt, make sure you get some help because debt can be … Talk about stressful and overwhelming. Debt is one of those things … Money can be a big impact on your emotional and your physical health and your family health, if you’re constantly worried about that. Make sure you’re getting help from that but if it’s just a question of, “How do I balance these things?”
Talk to some people you trust and find where does my family land on? What’s a right amount of focusing on the near term? And what’s the right amount of focus on the far term?
Austin Wilson:
Yeah. I think you hit the nail right on the head. The topic of debt, it’s a tricky one to navigate on your own. And it’s certainly a valuable topic of discussion with your financial advisor. And you should revisit it frequently because things change over time.
[36:28] – Invest with us!
Austin Wilson:
Josh and I want to let you guys know, as our listeners, we love you. We thank you for listening. We want to let you know that we are here to help. If you don’t have a financial advisor or if you simply want to hear more about what Josh and I do and the rest of the team here at Hixon Zuercher Capital Management, please check out the invest with us tab on our website. And we’ll link that below in the show notes. We work with a team of credentialed, experienced colleagues that have worked alongside our clients for nearly two decades, to help them achieve their financial goals. And we can help you too. Check it out. There’s no obligation but we’re just happy that you’re here but if you are interested, check it out.
Josh Robb:
Yep. And as always, we got on the website the eight principles of timeless investing. If you haven’t checked that out, please download it. It’s free. Just gives you overarching investment themes, help to keep you on track for your longterm goals. Check out the website. And then also Austin, how can they help us with the podcast?
Austin Wilson:
Yeah, we would love it if you would subscribe. If you’re not already subscribed, keep listening. We’re going to push out these episodes every single Thursday. If you really like what you hear, we’d love it if you’d leave us a review on Apple Podcasts. If you have any topics or questions that you’d like us to address and talk about in an episode, email us at hello@theinvesteddads.com and click that share button. If you liked this episode, share with someone who you may feel would really benefit from learning a little bit about debt and hopefully we can help someone out. We’re always just really focusing on helping you out.
Josh Robb:
All right, thank you guys. And we look forward to talking to you next week.
Austin Wilson:
Thanks. Bye.
Josh Robb:
Bye.
Outro:
Thank you for listening to the Invested Dads Podcast. This episode has ended but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review, click subscribe and don’t miss the next episode.
Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin, or any podcast guests, are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.
