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Your debt makes other people rich. You’re only borrowing from your future self, who will be poorer, less financially secure, or lead a less abundant life because you had to have it now, before you could really afford it.
You can’t save while you’re in debt, and like a weed it grows and grows. Kill it!
The only exception is debt you take on for investment purposes. Unless you run your own business, such ‘acceptable investment debt’ nearly always begins and ends with an affordable mortgage to buy property.
Borrowing to invest in shares is too risky. The market goes up over the long-term, which might make it seem like a good idea. But shares are volatile, and the market could easily go down over the 3-5 year time period of a personal loan.
You don’t want to have to sell your shares when they’re down to repay your capital – like that you’ll end up poorer than when you began.
Very occasionally debt might be acceptable if you need to buy something to earn more money, and you really can’t save it up.
For instance, you may need specific training to upgrade your job, or perhaps you want to buy an ice cream van to whip up a fortune. (Don’t laugh, it worked for Duncan Bannatyne
You’ll have to use your judgement here. Buying a fancy car with debt to impress your boss certainly doesn’t count!
But let’s be honest, we all know the kind of debt I really mean – excess clothes piled up using store cards, overseas holidays put on the credit card, a dozen sundry items bought over a week on the ‘never never’ as our grandparents ironically called credit.
This kind of debt – the kind of non-mortgage debt that most people take on – will make you poor if you’re not doing very well already, and it will stop you becoming rich if you are.
Too extreme? Everyone has debt, you say – surely millions of people can’t be wrong?
I disagree. I think the popularity of debt is down to:
- Relentless emotional marketing by retailers to persuade us that we must have things we never knew we needed and most probably don’t.
- Relentless emotional marketing by financial firms, who tell us we can have those things – now.
- People being too impatient nowadays to save for anything.
Perhaps I sound old-fashioned, but I believe we need to relearn some of these old ways of thinking.
Financially, debt makes no sense in my view, whatever economists tell you about balancing ‘consumption over a lifetime’ or similar wealth-sapping baloney.
In reality:
- Debt makes everything much more expensive
- While you’re paying off debts you’re not saving and investing
- Debt saps your efforts to make more money
- You’re not getting anything ‘free’ when you buy on credit, you’re only borrowing from your future self, who will be poorer as a result of your debts
Let’s look at each of these in more detail.
Debt makes your purchases twice as expensive
Say you’re shopping for a bed for your new home. Fair enough, you can’t sleep on the floor, and you’ve gone to a low cost retailer to buy a functional and reasonably priced place to spend the least productive eight hours of your day.
Actually, it’s not your first trip to this store – you’ve a new apartment to furnish, after all – and a few months ago you took out its storecard. For this you got 5% off your first purchase on the card, and a free set of chopping boards for the kitchen.
You can’t remember exactly what you used the 5% rebate for, but now you’re here you might as well use the store card to buy the bed, right? You choose to spend £350 on a keenly-priced but reasonably attractive bed and mattress.
All very well, but on your long trip from the bed department to the tills you also spend £200 on things you don’t need – new picture frames, a foot stool, a bathroom mirror, an ice-cream making machine and a set of solar-powered garden lights.
Time passes and the bill comes. There’s a bit of interest to pay, but you only have to repay a minimum of 2.5% back a month. It doesn’t sound like much and you’re tight on cash – you’re refurbishing a new pad, after all!
In fact, you only pay the minimum amount off every month – why rush, when money is tight and the repayments so affordable?
If someone asked you what the interest rate was you couldn’t say, but in the small print you’ll find it’s 19% – about average for a major name High Street store card, where interest rates typically range between 15-30%.
Here’s what these decisions cost you:
Bed = £350
Sundry items = £200
Total spent on card = £550
Interest rate = 19% a year
Minimum payment = 2.5% per month
Total time to repay debt = 99 months
Total interest paid = £497.76
Final amount paid over 99 months = £1,047.76
Ouch! By paying off just the minimum amount each month, it takes you over eight years to repay the debt! And just look at the interest bill – it’s virtually doubled the cost of your shopping trip.
In other words, you pay twice as much as your bed and bits and bobs actually cost, and you’re still paying the debt off nearly a decade later because many years ago you made a poor decision.
It’s easy to see from this example how people who don’t pay attention can turn a few years of sloppy shopping into a serious debt problem, especially if they only pay the minimum amount each month (which barely covers the interest bill in the early years).
I’d avoid even £550 of shopping debt like the plague, but it’s small beer these days – the average young person in trouble who called the Consumer Credit Counselling Service in 2006, for instance, owed over £12,000. Two out of every 100 callers owed over £100,000!
If you owe less, these depressing numbers should be motivation to get your debt down to £0, not an excuse to go higher. Most people in deep financial trouble began with a few hundred quid here and there. It adds up.
While you’re in debt, you’re not saving and investing
Spending over £1,000 on just £550 worth of furnishings and taking eight years to pay it off is bad enough, but it gets worse when you consider what else you might have done with your money.
Personally, I’d rather drink £500 worth of beer than pay it in interest to a bank – but I’d far prefer again to invest it towards my goal of financial freedom.
Let’s assume you saved up to buy your bed, mirror, attractive picture of a girl in the rain, and so on. You paid cash, and had no more payments to make afterwards.
What if you took the money you would have paid on interest over the next eight or so years and invested it in the stock market instead?
Let’s keep the sums simple and assume you saved £5 a month for those 99 months, or £495 in total.
According to the standard long-term study, on average the UK stockmarket has returned around 9.5% a year (or 7% above inflation), which is far better than cash, let alone money going the other way into debt.
Putting these numbers through a compound interest calculator:
First payment = £5
Regular monthly payment = £5
Assumed growth rate = 9.5%
Total after 99 months = £752
Does that astonish you? It should. Instead of spending £495 on interest, you’ve grown that £495 to over £750 – an increase of 50%.
Of course, shares should be held for the long-term – there’s no guarantee your £5 investment a month would compound by 9.5% in any particular year. But according to the history books, it’d be a good bet over eight years.
It gets better. Let’s suppose you discover you quite enjoy this saving lark, and decide to put the £752 towards your retirement.
We’ll assume you’re 30 – you bought your first bed eight years ago, after all – and you retire when you’re 70. What would the £752 be worth after you quit working?
Are you sitting down?
£28,365.
Incredible, isn’t it?
Now, that’s in today’s money – after 40 years of growth adjusted for inflation (around 7%), you’d have more like £11,000.
Still, that means you end up with 22 times more money than the interest that you’d otherwise have paid if you’d bought the bed on a store card all those years ago.
And remember, you haven’t gone without here – you still bought the bed out of your savings. We’ve only considered investing what you would have spent on the debt interest.
Another way of looking at it – your 70-year old self bought your 22-year old self that bed for £28,365! What a deal! (Not).
When you do these sorts of calculations, it’s very easy to see that saving from a young age will make you rich, while spending the same on debt repayments will leave you poor.
What’s the catch? Economists will tell you that your bed is worth more to you when you’re 22 – after all, you need somewhere to sleep – so it’s worth all that forgone cash.
What’s more, if you looked after a good bed it might stay with you for many years, whereas you can hardly wait until you’re 70 to buy your first.
There’s some truth in this, but the fact is that there’s always an alternative way to get a bed. You could get an old one from a friend. You could look on Freecycle. You could build a bed.
And while making do you can save up to buy the bed you really want, in cash, when you can afford it.
Life isn’t just about buying beds, but the principle is the same for all purchases. Delay and do without until you can afford something – don’t buy it with debt.
Debt worries will sap your efforts to make more money
I’ve shown above how debt makes everything far more expensive, how you’re only borrowing from your future self who will be poorer if you run up debts now, and how a policy of saving money instead of paying interest can lead to a rich retirement.
But there’s one more benefit of avoiding debt. It’s the hardest to pin a price on, but it’s probably the most valuable benefit of all. It’s the price of peace of mind.
When you’ve no debts, you literally don’t owe anyone anything. Your money is yours to do with as you will.
Of course you’ll owe your parents for raising you, your friends for helping you out, and you’ll want to buy a beer for whoever gave you that old bed – but financially speaking, you’re free.
I’ve heard many times from people who’ve gotten out of debt how liberating it is to look at their financial futures knowing they’re not going to waste money for years to come on things they bought and forgot long ago.
Rather than being chained to a treadmill of paying off their debts to other people, they are free to save up a rainy day fund, invest for the future – and treat themselves to a meal out or a bottle of wine paid for out of this month’s earnings.
Even better, when you’re financially secure, you’re more likely to look for ways to make more money. Everyone knows the rich get richer, and the sums above show that the power of compound interest is one reason why.
But I believe there’s also a mental pay-off for the debt-free.
Operating from a position of strength, you are far more likely to think of money as an opportunity and a tool, rather than as a burden. I know that’s been my experience.
I admit we all know people who can seemingly handle their debts and whose income is growing faster than their repayments. I’m not saying debt is a fatal disease – rather that it’s a debilitating one.
How much richer would those cashflow strong, asset poor debt jugglers be if instead of shuffling their credit card payments or store card balances, they put the same brainpower into growing their investments or developing a second income stream?
They’ll never know unless they pay off their debts, but my guess would be far richer than even the huge savings in interest payments would make them.
Sure they’d have to go without a little, now. But all that really matters in life is health, friends, family, love, and work or some other purpose you enjoy.
Last I looked, buying a widescreen plasma TV before anyone else in the office wasn’t on a single philosopher’s list.
The bottom line on debt. Don’t do it.
Get out of debt, and stay out of debt. You’ll earn money instead of paying it, you’ll end up richer instead of poorer, and the only downside is you’ll spend less hours dealing with bored 17-year old staff at your local electronics retailer – at least until your savings have caught up with your desires.
(Actually, my guess is when you’ve got the money in the bank you’ll not want to spend so much on pointless gadgets and gizmos…)
I’ll look at how to get out of debt in detail in a future post.
The short version is cut up all your cards to avoid getting new debt, target the cards with the highest interest first, pay as much over the minimum as you can each month, and consider shuffling debt onto 0% interest cards if you’re sure you’ll keep up your repayments.
Please do subscribe to my feed to get the long version when it’s written, and do point out this article to any relevant friends.
If we save one person from debt, it was worth all the typing.
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