“If we could sell our experiences for what they cost us, we’d all be millionaires.”
I am not a fan of consumer debt. I have gone on the record as saying that there is no such thing as good debt. I was neck deep in credit card debt with absolutely nothing to show for it but some good memories. I’ve been stuck with a mortgage on a non-performing real estate investment property. As I discussed in my appearance on the Bigger Pockets podcast, we only pay cash for investment properties.
I also have been a beneficiary of debt. I leaned on Sallie Mae to fund my way through a top ten MBA program, and, as I demonstrated in my article on DQYDJ.net, debt to pay for graduate school can, in the right circumstances, be a reasonably good investment.
But, for a lot of people, the answer is simple. Debt is bad. When someone asks me if they should pay extra against the mortgage or invest that money, I know the expected value of investing is higher, but loss aversion and our financial inability to deal with the downside of events if they don’t go exactly as planned lead me to say pay down the mortgage first.
However, there is one group of people for whom I don’t care whether or not they have consumer debt.
Why I Don’t Care if Millionaires Have a Little Debt
The argument for using debt rather than paying for something in cash usually goes along these lines:
I can borrow the money at X% [some nominally low interest rate], invest it in the market at Y% [which is conveniently higher than X%], and keep the difference!
If you look at the averages, this makes sense. For example, the current mortgage rate for a 15 year mortgage, according to Bankrate, is 3.37%.
The compound average growth rate of the S&P 500 from 1871 through 2013 was 9.07%. Subtract 3.37% from 9.07% and you make 5.7% on the difference.
It’s not quite as failproof as you think.
While the averages work out in favor of this strategy, if we look at the actual returns of the S&P 500, we see that there’s more to the story.
We wind up trying to squeeze out a few extra dollars and take a 1 in 3 risk that it’s not going to work out, and we’re going to have to come up with additional money out of our pockets to make up the difference.
And that, Dear Reader, is why I don’t care if the millionaires have car loans.
On the other hand, deviating from your path to meeting your financial goals, such as what we saw in “Do You Need to Save Money in Your 20s?”, means that you’ve increased the slope of that uphill climb to get where you want to be.
While I’m fine with having a 5% “swing for the fences” fund, the difference between that and trying to invest the difference between your assets and your debts is that with the 5% “swing for the fences” fund, you’re not going to have to be out of pocket further if the bet doesn’t work out. However, if you’re trying to invest the money for a car loan, for example, and it doesn’t work you, you still have a car loan to service.
People who have reached their financial goals have earned the ability to take those risks because they have the financial wherewithal to deal with the downside. If you make a million dollars a year and have a forty thousand dollar car loan because you’re investing that money – assuming that your expenses aren’t a million a year, of course – then if that investment tanks, the subsequent extra spent to cover that money will hardly make a ripple in the water.
The calculations won’t even scale to compare to someone who makes, say, $50,000 a year (as if you could get a car loan for $2,000). In analogy, though, $2,000 means a lot more to the person making $2,000 a year than $40,000 does to the person who makes a million a year.
Would I encourage the well off, high income, or financially independent to get loans and invest the difference? Of course not! But, neither will it cause me heartburn if they do that.
They’ve earned that choice.