The Aleph Blog » Blog Archive » Avoid Debt Unless it is to Purchase an Appreciating Asset

Avoid Debt Unless it is to Purchase an Appreciating Asset

I’m generally against debt.  I’ve been debt-free for the past five years.  It allows me to take prudent risks with my investments.  So, when I read things like this in The Economist’s Free Exchange Blog, I shake my head.  Here’s the main quotation:

My friends who study humanities are shocked and do not believe me when I, a pension economist, tell them they should not be saving. Prudent advice has become: You should always save some fraction of your income. You should save not only for retirement, but also for adverse income shocks. But, Mr Becker points out, these new lines of credit help workers cope with income shocks.

The pension economist is wrong, mainly.  So is Dr. Becker.  It is reasonable to take on debt to gain an education for a career that is lucrative; it is not reasonable for something that does not pay well.  Following your heart into a career is a good thing, but if the field doesn’t pay well, don’t saddle yourself with debt to get there.  I know too many young people with large debts in their 20s with no reasonable way to pay them off.  They may be in the field that they love, but they are miserable due to the debt.

It is also reasonable to take on debt for an asset that will appreciate over time at a rate greater than the financing rate on the debt.  Note that I did not say housing here, though that is normally the case.

I counsel all of my kids, and all of my friends to avoid debt where it does not pay, particularly for consumption.  Pay off your credit cards in full each month.  If you can’t do that, cut up your credit cards, and learn to make do without them.

The advantage in life always comes to the man who has surplus, who receives a discount for paying upfront, rather than over time.  You should live below your means, and build up a buffer against the future.  Theoreticians like Dr. Becker essentially say, “Don’t worry, they’ll loan you the money.”  Ridiculous.  First, if they do loan, it is at horrendous rates.  Second, during a credit crunch, all cheap sources of financing disappear for all but the most creditworthy borrowers.  Credit disappears when you need it most.

Saving at young ages sets the tone for the rest of life.  The lifecycle saving hypothesis (of Milton Friedman) is wrong, because most people don’t possess the discipline to switch between being a borrower to being a saver.  Many do it, but not the majority. I saved money when I was a grad student, though most of my colleagues did not.

My advice to you is to develop careful spending habits, particularly if you are young.  What you do now will affect your ability to save for the rest of your life.  Borrow for things that have large long-term payoffs.  Delay purchases for short-term gratification.






bloggerbuzzdeliciousdiggfacebookgooglelinkedinmyspacenetvibesnewsvineredditslashdotstumbleupontechnoratitwitteryahoo
Ethics, Personal Finance | RSS 2.0 |

One Response to Avoid Debt Unless it is to Purchase an Appreciating Asset

  1. Frank says:

    Thanks David. My father hammered that message home to me and it has served me well. I need to remember to hammer it home to my kids.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

 Subscribe in a reader

 Subscribe in a reader (comments)

Subscribe to RSS Feed

Enter your Email


Preview | Powered by FeedBlitz

Seeking Alpha Certified

Top markets blogs award

The Aleph Blog

Top markets blogs

InstantBull.com: Bull, Boards & Blogs

Blog Directory - Blogged

IStockAnalyst

Benzinga.com supporter

All Economists Contributor

Business Finance Blogs
OnToplist is optimized by SEO
Add blog to our blog directory.

Page optimized by WP Minify WordPress Plugin