Many financial planning clients rank paying off debt as one of their highest financial priorities. After all, owing no money allows them to stretch their income much further and save more. But recent statistics indicate that a growing number of Americans are further away from this goal than ever. The Federal Reserve Bank recently published a report indicating that in 2016 the total debt carried by all American households rose more than it has in a decade, and is likely to set another record this year. But is debt always a bad thing?
Taking Advantage of Debt
Thomas Anderson, a former investment banker and CEO of Supernova Companies, offers a contrarian philosophy to financial advisors when it comes to talking about debt. He feels that it is debt, not equity, that can make a positive difference for clients. “The biggest determining factor in whether or not you’re going to succeed long term is the decisions you make with respect to debt,” he says.
Anderson’s new book, The Value of Debt in Building Wealthpostulates that consumers should not look at debt as a burden but should rather embrace and accept it as a means of buying assets and reducing their tax bills. Anderson argues that using debt to finance investments can produce higher final balances than investments that are funded entirely with cash. He considers debt that carries a low rate of interest to be “enriching debt” as having this debt can allow the consumer to invest other money in assets that produce a higher return on capital over time due to the power of compounding.
In his book he cautions advisors that those who ignore the debt factor in their recommendations may be short-changing their clients. He backs up his assertion by comparing three households: the first household uses all of its discretionary income to pay off debt, the second makes the normal payments on its debt and saves some money, and the third only makes the minimum payments on its debt and invests the rest.
The third household ends up the winner after 30 years because its investments grew the most in relation to its debt. “That’s why the decision with debt matters more than the decision with asset allocation. It’s driving the amount of money compounding over a long period of time. You can finance assets. Instead of tying up money in a house you can put it in your portfolio. Thirty-five years of compounding at a lower rate is more powerful than 10 years of compounding at a higher rate,” he explains. (For more, see: The Big Difference Between Good Debt and Bad Debt.)
How Advisors Can Help
Financial advisors can help individuals manage their debt through the use of debt consolidation loans and repayment plans. Those with high student loan debt may want to consider refinancing with one of the new, innovative student loan companies such as SoFi, which offers a variety of deferment programs as well as assistance with getting a job and starting a business.
They can also help prospective homebuyers to get the best possible deal on their mortgage and show them what they need to do to improve their credit scores. Clients who are more sophisticated investors may also want to consider trading on margin in order to leverage their investment gains (although there is an additional risk in doing this).
The Bottom Line
Although debt is viewed as primarily bad by most people, there are times when its use can be warranted in order to achieve a higher rate of return on investments over time. Advisors can help individuals learn when to use debt and when to use other means in order to achieve financial goals. (For more, see: This Is How Financial Advisors Can Help with Debt.)