“Felix qui nihil debet (happy is he who owes nothing)” – Roman Proverb
Debt is this century’s version of indentured servitude. Historically, indentured servants traded their freedom for safe passage to another country. If they couldn’t pay enough to secure their ticket to the “New World,” another person would pay their passage in exchange for 3-7 years of their life, which was spent doing hard labor or household duties for their new master.
Debt is purchasing goods or services today in exchange for tomorrow’s money. It’s a seductive offer – a promise and a contract for instant gratification instead of months (or years) of saving and waiting. It’s doubly seductive when you’re purchasing an “investment” – something that promises to make you even more money down the road, like a house or a degree.
The problem with debt is that it creates huge invisible opportunity costs. Take, for example, someone who successfully obtains a $100,000 MBA from an Ivy League school. Will it open doors? Sure. But as some doors open, others close.
How easy will it be for our hypothetical newly-minted MBA to drop everything and travel abroad for a few years, living cheaply and working odd jobs to earn their keep? It’d be almost impossible to have this life-changing experience, even if he/she wanted it badly – the tuition bill must be paid.
How easy will it be to work for a non-profit, the social sector, or education, where wages are typically low? Not very easy at all, even if they feel called to the work – large debts require large (and consistent) paychecks.
How easy will it be to give up a life of 120-hour-a-week consulting or financial services work to attempt to start their own business? Reaching the point of sufficiency for the new startup will be more difficult than it already is – it’s hard to be “ramen profitable” with a thousand-dollar-a-month student loan that must be paid every month on top of earthly necessities.
By taking on debt, you’re giving up all of the things you could do with the monthly debt service in the future until the debt is repaid. With large sums and long timeframes, you’re forgoing a huge amount of valuable flexibility without understanding the full extent of what you’re giving up.
There’s a reason that many Fortune 50 companies offer to pay your relocation and closing costs when you buy a new house – once you’re saddled with a mortgage, it’s harder for you to leave the company, even if you want to. Good for them, bad for you.
The Benefits of Debt
Debt can be beneficial in the same way that fire is beneficial – it can be a useful tool, but you’ll get burned if you’re not careful.
Here’s an example: I used a credit card to purchase the laptop I’m using right now. It’s the primary tool I use in my work – I use it to write, manage this website, communicate with clients, and finish projects. Having a good computer makes it much easier to do my work, so I took on a reasonable amount of debt to obtain a good one.
Taking on a small amount of debt gave me access to a very useful tool 2-3 months before I’d be able to save enough money to purchase one with cash, and actually having the computer gave me the capability to pay it off a month later. That was a good investment, and a good use of debt.
Small revolving debts usually won’t get you in trouble. Debt becomes destructive as the amount gets bigger, either through large investments or the accumulation of small purchases.
The easiest way to stay out of debt is to avoid taking it on in the first place. Here’s a useful rule of thumb that’ll keep you out of trouble: if it’s not going to help you make more money within the next 3 months, don’t take on debt to buy it. That goes for everything from household goods to movie tickets.
Your Personal War on Debt
Repaying all outstanding debt is the first step of re-claiming your own personal sovereignty. It’s not easy, but the increased control you’ll have over your own life and choices is well worth the effort.
Here are a few books that will help you tackle your current debt, as well as resist the temptation of taking on new obligations:
- Your Money or Your Life by Joel Dominguez & Vicki Robin
- I Will Teach You to Be Rich by Ramit Sethi
- It’s Not About the Money by Brent Kessel
There are also quite a few fantastic personal finance blogs you can also follow for useful advice and perspective. Here are my favorites:
As I mentioned in my interview with David McKelfresh, I used debt to finance some of my business’ startup costs, and I’m still paying a few of those debts down. My goal is to have 100% of my debt eliminated by the end of this year, and I’m looking forward to the day when I don’t owe anyone a dime.
What are you currently doing to manage your debts? What do you do to keep yourself from taking on more? Share your thoughts in the comments.
(Photo credit: nusrin on sxc.hu)
{ 16 comments… read them below or add one }
Man this is the worst thing to click on after having literally just submitted online my $58,000 loan application for the second year of my MBA. Two small lights in the tunnel:
1. Getting money instead of plates for wedding presents will indeed allow me to travel next year.
2. I do want to work for a social venture, and luckily I’m ok with giving up a few luxuries to be able to afford loan payments and food. We’ll see later what really happens.
Also, some schools like Stanford offer help to students who pursue social-related careers for paying back loans. One could also take the position that they are now even more than ever forced to use their so-called new skills creatively to make a social venture earn money or a start a really great company.
There are ways to deal with it, but yes, debt still totally sucks.
Add 4 kids to the mix and then life gets really interesting!
Like Ramit, fear of debt was ingrained in me by my parents. Whenever I have debt owed, it’s like a nagging itch in the back of mind that won’t go away. I try to pay it off as fast as I can.
Couple of more examples of useful debt. One, Bill Me Later. This can be a very dangerous exercise if you’re not disciplined because the interest rates are brutal, but it allows you to extend a flight or purchase for 3 more months. I’ve used this when I’m mid billing cycles to avoid having to load my credit card with another $500. Then I put several alerts for 2 weeks prior to the 3 month marker to transfer the $500 in my checking account.
Another example, which I just settled, was reducing my overall payment for my car in order to support an increase in health insurance costs. While this prolongs my debt for another few years, it offsets another major add-on to my budget. There’s no penalty to early payment, so it’s a no-brainer.
Anyway, the core of what you’re getting at is debt isn’t free money. It’s a strategic asset that individuals can use just like companies do to benefit their bottomline.
You should checkout this article on Heller Erhman, a San Francisco Bay Area Law Firm imploded a couple of years ago. They were heavy dependent on debt financing to run their business and it just cratered them.
http://www.pehub.com/46976/how-heller-ehrman-went-under/
Income is not guaranteed.
Income is not guaranteed.
Income is not guaranteed.
Income is not guaranteed.
But debt is a pain in the buttocks to get rid of.
I like the reference here to the opportunity lost if you limit your employment choices in order to support debt repayment. I’ve not thought about it that way before and I think it’s a significant factor, in terms of both sets of benefactors: the giver and the receiver.
Debt is a terrible thing to have upon you, yet at times there’s no other option, specially when you only have a window of opportunity that will not wait a year for you to get the money.
And so, it is a double-edged sword, and needs great care and responsibility for it can destroy all you’ve built in the blink of an eye. So, to handle it, it’s really a risk analysis and what you want to do in time. For example, I took a small school loan to pay my last year of college and that allowed me to have a lot more flexibility on how I used the money I was making, helping me make other investments and face other obligations without much worry. Of course, I took the risk of losing my income or not getting the raise I needed (luckily I did) but for that I had contingency plans in place.
So, is your goal so critical that you are willing to use the sword? Are you really prepared to use it? Are you commited enough to not long for a change mid-way? Answering these three might tell you if you are ready to use debt, and if you hesitate to take the risk, then seek investors willing to share the burden and danger.
Another good financial website is http://www.gailvazoxlade.com, which helps the average person get out of debt.
From “Your Money or Your Life,” my favorite concept is that by buying something with debt, you literally become a slave to that possession. Imagining yourself as a slave to an inanimate object feels so ludicrous that it makes it easier to turn off your habitual spending patterns.
The best thing I did when I was trying to get out of debt was to take out only as much cash as I had budgeted myself for any 2 week period. I had to be a strict enforcer of myself not to take any more out, thus prolonging the debt cycle for “necessary” things like schmancy balsalmic vinegar or (more) new shoes. Having the mental image that everything in my wallet had to last me for 14 days made me much more aware of little costs, and let me make some serious value judgements. Now, when I have space for the little things in the budget, they are total luxuries!
Good article. Comparing debt to fire is a great analogy.
One problem with debt is that we don’t tend to consider worst-case scenarios. What happens if my salary goes down instead of up? What if I lose my job? What if something crazy happens to the economy, and it doesn’t recover for years?
While researching my recent book, I delved into the life of Thomas Jefferson. Here was a guy so brilliant that when John F. Kennedy entertained 49 Nobel Prize winners at the White House, he said,
“I think this is the most extraordinary collection of talent and of human knowledge that has ever been gathered together at the White House – with the possible exception of when Thomas Jefferson dined alone.”
So Jefferson inherited a thousand acres of land in his 20′s, but also some debt. He always felt that, if things got tight, he could sell off some of the land. But he didn’t pay close enough attention to his debts and spent his latter years – when he should have been basking in the glory of his remarkable life and playing with grand kids – fretting about how to not leave his children with his huge debts, which, in today’s money, would have been in the millions.
So why couldn’t he just sell his land? Well, drought had devastated his crops, followed by invasion of a destructive fly. The Panic of 1819 made money tight and nobody wanted to buy land.
Not even Jefferson could have predicted the chain of events that led to his financial demise. After reflecting upon that, I decided to sell a rental house that I had money borrowed on. If everything went fine in the coming years, it would be a great investment. But calculating worst-case scenarios made me realize it wasn’t worth the risk.
Steve Miller, author of Enjoy Your Money! How to Make It, Save It, Invest It and Give It – http://www.amazon.com/Enjoy-Your-Money-Make-Invest/dp/098187567X/ref=sr_1_2?ie=UTF8&s=books&qid=1237211789&sr=8-2
I just got out of my undergrad and have started working at a big bank. I’m actually thinking of going back for an MBA at a top tier school because of how IT is being offshored and outsourced. I feel like the only way for me to switch careers is to go back to school. When employers look at my past work experience ( a few internships doing IT), I think they tend to assume I want more tech stuff, and that IT is the only thing I’m good at. How do I get myself out of that career “typecasting”.
If the value of the asset(s) associated with the debt does not increase in value over the debt, then this is bad debt.
http://daveramsey.com has great practical steps on how to get out of debt.
I for one am glad that I never went back to school for an MBA. With the exception of my mortgage, I have been debt free for well over 10 years. I actually considered putting my career on hold and seeking an MBA full time.
Josh’s program persuaded me otherwise and I have since been able to accelerate my career on my own!
The trouble with this advice, like all good advice, is that it’s very difficult to put it into context. I resented my student loan for a long, long time. Then I realized I really did not have another choice. I’m a single data point, but I think my story is a good one to make this point!
I grew up in a working poor family that lived in a “bad” neighborhood with a “bad” school system. As luck would have it, I ended up at an elite prep school on scholarship. At 17, I graduated and went to Stanford, where I took out loans.
My loans certainly constrained my choices after graduation. However, the likelihood was negligible that I would have found ANY other way from the world of “the inner city” to the world of high-tech startups and innovative social sector projects and other things I’ve been involved with. Alternatives like the Personal MBA were not so easy to find pre-Internet! Even if I had been able to find them, I would not have had the wherewithal to understand and apply the information without the cultural education I received among the kids of business owners, professionals, and wealthier people.
Debt is often the only bridge at hand.
I am always wary of singular ways of thinking about one thing. Like debt is bad or debt is good. At the end of the day, without debt, there is no world economy. No business can function without debt. We all create debt by crediting our suppliers or need capital to develop our businesses towards the next step. Without debt there would be no google for example. Debt can give us focus since it’s function is to limit our choice by creating an obligation. Too much choice is also bad. I’ve been wandering around the world and my inner world for years. Now that I’m marry and have a mortgage, I feel great! Its given me a focus rather than a possibility. Not everyone can opportunise every possibility. Yes choice is important to have and it represents freedom to most western cultures. But choice is not perceived the same in different cultures too and hence neither is debt. Refer to recent ted talk on choice. Can’t remember her name.
My point is that what we are really talking about here is simply how important it is to invest well and how to manage it’s cost of investment / debt. Now that, although sounds simple, is the challenge every one of us tries to get right.
My
Debt can be a nefarious thing. It is easy to go into debt but the easy access of money has dumbed us down and destroyed some of our creativity. There are so many options out there to pay for things (heck just negotiating) that we have forgotten because debt is so easy.
My wife and I are 4 months away from paying off our student loans. My education was great but if I could do it over I would take longer to graduate to not be in debt.
Josh Bulloc
Kansas City, MO