Hypothetical situations:
Guy A:
He has $0 to his name but is completely debt free. He's in his 40s but lost a lot in his divorce, but the kids are grown, moved out, and perfectly self-sufficient. His expenses and income balance but he's not saving any money. He does have a budget for travel, nights out, decent food and swanky yet surprisingly affordable rental home. A secure job with a well-funded defined pension plan. His monthly GROSS is about $6000. (He's not a reckless spender but just doesn't have anything tying him down and wants to live a little after his marriage exploded... Victim of getting married to young)
Girl B:
Has $1.5 Million of debt but it's financed at Prime. But owns a portion of a property management business. Her net-worth however is right around $0. Her business is profitable and generates a steady cash flow of $8000+ per month. After paying interest on her loan she's left with $5250 which thanks to clever accountants is not taxable income. The catch is that the value of her share of the business goes up and she will pay a larger capital gain when she decides to sell her stake. Aside from her property management company she has NO JOB and NO PENSION. She is a young widow who lost her husband to cancer. They have a small child whom she looks after full time. As they were both in their late 20s when they started their family, he had no life insurance.
Assumptions: Make your own. NB: Medical bills are NOT the source of her debt. I live in Canada and nobody gets stuck with grotesque medical bills for acute care. After taxes, SHE takes home a bit more every month.
Discussion: Who is better off? He's got a clean slate, but he works too many hours. Should the girl SELL some of her ownership of her business to help pay down her debt? Should she re-invest some of her business income to help generate MORE monthly cash-flow? Or should she try to pay it down as fast as possible?
Lastly: This is a trick question designed to illustrate something that my investing friends will pickup on instantly.
Ok... now go away and think about it, then comment below BEFORE reading on.
Please don't read this part until you comment....
I see you... You haven't commented yet... jerk.
Anyway here I go.
The man while debt free, is a wage-slave. If he gets sick or injured he will lose income. (Some, if not all.) In the event of a debilitating illness he might even wind up on disability and be forced into a radical downsizing.
The girl is by far better off. Yes she lost her husband to Cancer, but
this is a financial blog! She doesn't have to work EVER again and
thanks to her SAVVY INVESTING. Her montly income is steady (and slowly increases) and it's almost completely tax free.
If she sold her SHARES to pay down her debts, then she
would have NO monthly income. She would be broke and destitute. Her
investments include a basket of mostly REITs (Real Estate Investment
Trusts) and some dividend paying companies like Canadian banks and
utilities. Yes she has $1.5M in debt, but the monthly investment
proceeds covers the loan interest and her modest yet adequate
lifestyle. Baring the US annexing Canada her investments will be safe
and secure for the rest of her life. Her payouts will increase over
time and her debt will depreciate over time due to inflation! (This is
why I think it's foolish to pay down mortgages aggressively... the
higher the rate of inflation the SLOWER you should pay it down)
Yes this was a trick question. But folks out there in the blog-o-sphere... Debt is not your enemy. Money doesn't make the world go around. DEBT does.
Stay hungry my friends.
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