To Debt or Not to Debt?
Debt. To some, the word alone brings up stress, shame and feelings of overwhelm. For others, it makes them think of opportunity, goals and a means to and end. A lot of Financial Coaches have a strict no debt stance, but I am not one of those coaches. Here is what I mean.
We are all going to make a certain amount of money in our lifetimes. Those with a college degree will earn an average of a little over $2M in their lifetime. (Tamborini, Chirstopher R, ChangHwan Kim, and Arthur Sakamoto, 2015. “Education and Lifetime Earnings in the United States” Demography 52:1383-1407) When we start our careers we will make far less than what we will make in the middle to late stages of our careers. To see where I am going it is important to understand a theory called The Law of Diminishing Marginal Utility. Stated plainly, it means after a certain amount of a thing, you get less joy out of having more of that thing, In this case, the thing is money spent. So after some point the amount of joy you get from spending the next dollar diminishes the more you spend.
For example, we have all experienced the pain of trying to buy our parents something for Christmas. When you are in your 20s and still trying to save for a house, get a new car or go on a vacation, you have no problem telling your parents what they can buy you as a gift. The options are endless. On the contrary, when you ask a parent what they want for the holidays they inevitably say, “Don’t buy me anything there is nothing I need that I don’t already have”. They will get little to no joy from spending additional money because they have all that they need. They have reached the point of Diminishing Marginal Utility.
Why does this matter when it comes to debt? Here is my philosophy. Debt, used correctly as a tool and for the right reasons is a good thing. It takes a certain amount of spending each year in order to live a life that is fulfilling. In order to have a fulfilling job, you might need to borrow to buy an education. In order to get yourself to that fulfilling job you will likely need to borrow when you are younger to get a car. You might even splurge to go on a vacation that requires you to take on debt. This is OK, assuming you keep the following in mind:
1. You have a finite amount of money you are going to make in your lifetime
2. Every dollar you go into debt is taking money from the older version of you and sucking it into your pocket so younger, broker you can use it now
3. You still cannot spend more than your lifetime earnings . Older you will need to eat, have shelter, be clothed and have a little fun too.
4. The key to making this work is not having lifestyle creep as you make more money. If $2.2M is going to last for your entire life you cannot stay in debt forever. At some point our income needs to be more than enough to cover day to day expenses and allow you to save.
So basically, it is ok to borrow to take care of broke young you who has not yet reached that point of diminishing marginal utility of income to enjoy life now. Just remember older future you is going to need you to be responsible and have a plan so you can continue to live a comfortable, fulfilling life well into retirement.