A reader wrote to me recently stating that she had about $40,000 in student loan debt at 4% (she locked in in late 2002 when the rates were in the basement), and she couldn’t decide if she should be making extra payments on the debt. My advice to her was to figure out how much she could afford for payments each month, then just make the minimum payment and put the remainder in a savings account that earns 5% or better.
She wrote back with the following:
This is why personal finance doesn’t make sense to me. Different people give different advice all the time. I listened to Dave Ramsey the other day, and someone called in with almost the same question, and he told them to pay off the debt and get debt-free. I think you both believe that you’re right, but it just confuses people.
The big problem is that you’re talking about two somewhat different personal finance philosophies. I agree with a lot of what Dave has to say, but Dave holds a central philosophy that all debt is always bad, and you should seek to be debt-free before doing anything else. I don’t necessarily agree with that philosophy in some cases, and one of them is a low-interest debt brought on for a good reason, like getting an education.
Here are a few of the more common philosophies that I’ve seen roaming around:
The “all debt is bad” philosophy As I noted above, this is the philosophy that Dave Ramsey promotes. The idea behind it is that debt means you’re effectively a money slave to someone else. This plan removes debt quite well but can leave you very vulnerable if you do it too vigorously.
The “only high interest debt is bad” philosophy. I find myself in this group. Low-interest debt, like the student loan debt above, should be left alone, and you should only avoid high-interest debt (right now, anything over 7% or so); instead, you should be building up a big emergency fund and a fund to buy more expensive things (like cars) with cash. This plan offers breathing room and security but does leave some debt in place.
The “leverage is the way to get ahead” philosophy. This is the general philosophy that folks like Robert Kiyosaki promote. Basically, debt is great as long as it puts you in a situation to make a profit, but it does require some business sense and a plan.
Which one is right? I honestly can’t tell you that. It depends on your temperament and your beliefs, mostly. I’m a pretty big fan of a big emergency fund and leaving low-interest debts alone, but I can see the logic behind other philosophies, and I can easily understand why people might subscribe to them.
All of those philosophies have clear advantages and disadvantages, and you’re not “wrong” by choosing one over the other as long as you’ve spent the time thinking about them and figuring out which one rings true for you. Some people will offer compelling arguments why one is better than the other, but quite often, they rely on focusing on one particular attribute of the philosophy. Ramsey’s plan, for example, can show massive debt eliminations quickly, but what sort of security against a major disaster did they have while doing it? Kiyosaki’s plan can show some huge profit, but what about the losses from people who didn’t see their small business succeed?
Listen to your heart. Your mind might not know all of the answers, but your heart will often point you towards the plan that’s right for you. Remember, the goal with all of these plans is to ensure that you’re in a better financial state tomorrow than you are today, and for the most part, they’ll all do that quite well.