Debt can be a nasty four-letter word
Real estate buyers and investors have been conditioned to believe there is good debt and bad debt. Debt used to acquire assets that appreciated - houses, for example - was acceptable. Today, it might not be as cut-and-dried as that.
Before the real estate crash, it was assumed that the appreciation of your property would more than make up for the cost to acquire it -- your debt. Now that appreciation is much more questionable these days, it has made many real estate investors re-examine how leveraged they should be in their investment assets.
Real estate is a solid investment in that, long-term, properties will still appreciate. And if you can afford to do it without taking on burdensome debt, now is the time to buy. The problem is for those who invested in properties during the bubble: Can properties purchased at the peak of the bubble cash flow enough for it to make sense to hold onto them long-term? Because of the kind of debt investors took on to acquire properties when credit was easy, they are not enjoying the same kind of cash flow investors in today's post-bubble market are enjoying.
Which brings us back to debt. It's not a good thing.
There was a recent study done by Scottrade -- the online investing firm -- that showed about 63 percent of people's retirement savings were affected by the debt they carried in 2009. The study showed that for 2010, even as lessons have been learned and a recovery is underway, 61 percent of people will have retirement savings be affected by their debt.
This perspective -- the impact of debt on your retirement -- provides a glaring example of how dangerous debt can be. Think about the retirements of the generations that went before us, for example.
Sure, when you retired, you stopped earning as much income. But, in general -- in our parents' or grandparents' time -- you also didn't NEED as much income. Your house was paid for. You paid off cars and kept driving them. You didn't have thousands of dollars of credit card payments to make.
But look at us now, the debt generation we have become. We took out exotic mortgages, or financed houses with little money down. We drive cars as expensive as the houses our grandparents lived in. We have student loans, credit card balances and home equity lines of credit.
Our grandparents didn't buy things without cash, so it might have seemed as though they had very little. We buy nothing with cash, and we have less cash. That's because buying on credit is way more expensive than buying with cash. Which means our retirements -- when, like our grandparents, our incomes will go down -- will be more challenging. Because of current debt:
1. We are not able to save as much for retirement now
2. We will need more money in retirement
In other words, debt costs our retirement savings now, AND will add to our income needs when we actually retire. So what to do about it?
Well, for years investors have been concerned about return on investments, the rates of return. But now the focus should turn on becoming debt-free, or as debt-free as possible. I know it's easier said than done, but if you take a minute to do some basic financial planning with the idea of attacking debt as your goal, you'll be amazed at what you can do. Instead of thinking "How can I earn the most money with my investments," ask "How can be free of debt?"
Think about it this way: If you're taking 2 percent out of each paycheck toward retirement and putting it in a fund that earns 8 to 10 percent annually, how smart is it to carry a $7,394 credit card balance (the U.S. average per household) with an 18.8-percent interest rate (also the U.S. average)? Putting the money toward debt relief is the smarter investment.
So a good strategy might be to use the retirement money from your paycheck to pay the debt off, then take the extra money you'll have from not making payments on that debt and apply it to your retirement savings. Or once the credit card is paid off, you can take the extra money to pay off other debt with higher rates -- maybe a car loan, or a second mortgage.
When financing a home purchase - again, there has perhaps not been as good a time to do so as now - think about being able to pay it off before retirement. Try to avoid exotic loans that make a home affordable now but could put you in trouble down the road. You don't want to be "house poor" when your income drops in retirement.
As for right now, attack the different debts you have one by one, starting with the highest interest rate you pay and working your way down. To be effective doing this, you'll also have to avoid going into further debt. One of the easiest ways to recover from borrowing too much money is to stop borrowing so much money!
The bottom line is that once you realize what a nasty four-letter word debt is, you can pursue financial independence from a debt-reduction standpoint, which, in this economy and in your retirement, will serve you well.
It's a good idea to sit down with a financial planner to get a good look at where you can expect to be in 20 years time, or what you should be doing to get where you want to be in 20 years. A good person to contact to discuss your financial goals is:
Christopher M. Cice, CRPC®
16 N. State St.
Newtown, PA 18940
215-579-9700
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