One line of thinking in discussion groups runs that one should not pay low interest debt off early, putting one’s extra cash into the market instead.
When you pay extra against a 3% student loan or mortgage you get a 3% guaranteed return on your money. Why settle for 3% when you can get 7-8% or more in an index fund, right? Even more so, why not take advantage of that 0.9% auto loan, even when you have the cash to pay for the vehicle outright?
On a best use of money basis, this argument is flawless. Time in market beats timing the market and you can never again invest in last year’s 401K (or equivalent).
However, there are other considerations.
For those of you who have positive cash flow on a number of rentals and a lucrative side hustle, perhaps a pension and maybe some other sources of income, this discussion does not apply – do what makes sense financially, get the most out of your money.
But for the rest of us, the vast majority of us, the job is the primary source of income. If you lose it, those debts will be a major burden in your life.
There are a number of ways you can lose that nice steady paycheck:
- Outsourcing or offshoring – your job just moved to a cheaper country.
- Business goes belly up – you show up at work one day and the doors are locked.
- Business is bought by a competitor and you have one of those support jobs that present ‘synergy’ value to the acquiring company.
- You suffer an injury that keeps you from working and you forgot to pay for long term disability
- The line of business you support is no longer needed and neither are you.
- The company switches technologies and you know nothing about the new technology.
- New management comes in and downsizes the organization you work for.
- You are a contractor for a large customer – the customer does not renew the contract.
I feel like I am in that insurance commercial with the moose and the swing where I can say I have seen all of these things before. Just learned today that a former colleague’s company has just been bought out. He may be a victim of synergy post-merger.
My first job out of college was with the Federal Government – one never loses these jobs, right? I came back from vacation to learn that I had been moved to another project (with no say as to which one). It was a dead-end job. I was not fired, but might never have gotten promoted again. So while I was not fired, I was incentivized to find something else.
I found a job at a federal contractor, back with the same customer, but was empowered to use my skills and contributed a lot. Got a lot of great travel and training as well. I rose quickly through the ranks. Turns out, when you are a contractor in a senior position, there are not as many positions on contracts for you and I had to scramble to stay employed as each contract came to an end. This all led to a good job with a growing company that I have held for twenty years, so my story has had a happy ending.
Back to the debt issue – student loans are not dis-chargeable in bankruptcy. While the other debts would be, who wants to go bankrupt? This has got to take a severe emotional toll on anyone accustomed to providing for their family and honorably paying their debts.
It took us 22 years to pay off our mortgage and it was an incredible feeling. The last 5 years, the loan was at 2.625% so I did not pay it off quicker, but the principle was relatively low so by then we would have survived. We have one small debt left on a rental property, but the property is doing well such that we pay extra once a year (instead of taking cash out, similar to declaring a dividend). I could pay the loan off if needed, so there is no real burden here.
So please consider the possible downside consequences of carrying too much debt and have a strategy to handle the alternate scenarios. Any one of them may be relatively rare, but all of them together present a real risk.