Why Paying Down Debt Faster is Not Always Better

I enjoy social media. Facebook, Twitter, and LinkedIn are my personal favorites but I’ve even thought of trying Instagram or SnapChat. I frequently see either advertisements or “financial experts” on social media promoting the latest debt reduction secret or plan that will get people to the promised land of financial freedom.

Now on its face, I have nothing against being debt-free or paying down debt, especially if it is credit card debt. Being debt-free can be psychologically satisfying and allows individuals sleep better at night. What I do take issue with is focusing on debt reduction at the expense of everything else, like savings and investing. In my mind, financial well-being (goal achievement) is more about asset collection, creation, and growth. (For more, see: How to Handle Market Volatility at the End of the Year.)

To not max out retirement plans (401(k)s, Roth IRAs etc.), college savings plans (529 plans) and non-retirement accounts (brokerage or advisory accounts) and focus on debt reduction exclusively is setting the majority of Americans up for failure. Here are some of the reasons why in my opinion.

Opportunity Cost of Not Investing

Leverage (which is what any loan essentially is), when manageable, frees up additional funds to do other things like saving for goals. Do any time value of money calculation. The longer you invest the greater your chance of accumulating real wealth. We’ve all seen the spreadsheets of someone starting to invest in their 20s in small increments versus someone who waits and then saves in their 40s or 50s at a higher rate. The 20 something always wins. Also, where are you going to get a better rate of return over the long term, in your house or your other assets? Historically, it’s been in these other assets (and you are right we don’t know what the future is going to bring but I would prefer to look at 100-year trends or more).

Money Is Cheap

Interest rates are at historic lows. Why would you want to pay off debt sooner when you can pay with future dollars? That is actually using inflation to your advantage. (For related reading, see: How to Budget and Spend to Maximize Your Happiness.)

Can’t Eat Your House

Socking money into debt reduction at the expense of other savings can potentially cause a shortfall in usable assets (those that are easy to liquidate and use) for the future. Houses are pretty illiquid and hard to convert to usable income if you need it at short notice.

Generic Advice from Pundits

I understand these people are trying to reach a broad swath of the population but when I hear “everyone” should do this it makes the veins on my bald head pop. Advice should be tailored because every family is different. If you are on track for your goals and want to use those excess dollars to pay down debt, go for it. But if you are short on the asset side of the ledger then you might need to re-evaluate what you are doing. Financial advisors are great at helping model these type of scenarios for clients. So if you are uncomfortable looking at all the options, take a little of that debt reduction money and hire a professional. The money spent should be worth your while. (For related reading, see: 5 Financial Strategies to Last a Lifetime.)



Michael J. Sicuranza CFP® AEP®

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