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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Debt tied to a depreciating asset. You do not appreciate debt tied to a depreciating asset. Welcome to the retire on time q and a podcast. I'm Mike Decker here with David Franson. As always, text your questions to (913) 363-1234 so we cannot talk about the oversimplified advice you've heard hundreds of times.
Mike:This show is all about getting into the nitty gritty. That said, remember, this is just a show. This is not financial advice. Don't listen to it and just do what we say. Make sure it's right for you.
Mike:Do your due diligence. Do your research. It's very important. Alright, David. What do we got today?
David:Hey, Mike. If I am ten years away from retirement but still have some debt, should I pay off my debt first or focus on saving in my IRA?
Mike:The question is predicated on the type of debt you have. Okay. So let's let's dive into the nitty gritty of this.
David:Yeah. Let's do it.
Mike:Alright. So alright. Different types of debt. Credit card debt, bad debt. Yeah.
Mike:Right? Car debt, bad debt. Why? The re not all debt is bad. Mhmm.
Mike:Debt tied to a depreciating asset. You do not appreciate debt tied to a depreciating asset Uh-huh. As in anything that has no value or the value is going down. Yeah. Your car is going down in value.
Mike:I mean, it did the second it left the lot. Your credit card, you've already spent it. You've got the value. There's no more future value, but you're paying two or three times or whatever the the rate is for that that thing that you got. Mhmm.
Mike:Okay? So if your debt is tied to a depreciating asset, there's a good chance that the rate is higher and that there's no reason to keep that debt around.
Mike:So that's the the cautionary tale. Now now good debt. Good debt would be debt that you've taken on at a reasonable rate, not predatory rate. K. A reasonable rate that's tied to an asset that is growing in value.
Mike:You appreciate debt that is tied to an asset that appreciates in value. Let me explain. Your house, hopefully, appreciates or grows in value. So you might have debt in your on your mortgage. Right?
Mike:You're paying your mortgage rate. It's four or 5%, whatever it is. Mhmm. Maybe you got a two or 3%, whatever those really low rates were. Right.
Mike:And and you look at it, it's like, well, hold on. I'm paying this, and the debt's going this far against me, but my neighborhood's growing in value. I'm actually making money on this. Like, that's not that bad of a situation.
Mike:Okay? So that's the first thing you gotta look at. And if you've got bad debt, pay it down quickly. Now the question then comes up, well, shouldn't I just put money in the market? Because the market's gonna grow at a higher rate than this debt.
Mike:Not necessarily. Now you've gotta compare the dollar amount or the cash flow compared to the interest each month that's going against you. Let me explain.
David:Okay. Okay.
Mike:So if you have credit card debt that's $20.25 percent, 30%, whatever it is Yeah. K? I think what I think 19% is the going rate for good credit. If if that's going against you each month, and let's say you've got 20,000 or so against you, look at the interest against you every month and then compare that to the interest you could grow.
Mike:So if there's more interest going against you than the growth in that year, you wanna pay down the debt that has more interest against you. It's like trying to run out of quicksand. You're sinking more than you're rising. Mhmm. You wanna get out of those situations.
Mike:Okay?
David:So interest against me would be, like, if I looked at my credit card statement and it said last month you were charged, I don't know, $80 on on credit card a. Credit card b, there's another 40. And then so all that's, like, going against you. Right? Yeah.
David:And going interest going for me, if I had my my savings account from my bank and I was earning one or 2%, oh, you made $5 in interest. So I'm out of balance there. I have more going against me than for me. Yeah. Okay.
Mike:Yeah. That's great. Great. Just simple explanation. Okay.
Mike:So so now you've gotta well, I mean and now you have to also compare the interest rate itself. So dollar for dollar, if you're not gonna make 19% in the market year over year.
Mike:But I can guarantee you that credit card company is going to charge you that interest every single year. Yeah. So my rule of thumb is any interest above whatever the ten year treasury is times or just just a little bit above that. So if the ten year treasury is, like, 4%, then 6% or greater interest, you probably ought to pay that down as quick as you can. Mhmm.
Mike:If your mortgage is 6% or less, then you need to ask yourself, okay. Well, how much interest? Like, let me say it differently. If you have a mortgage of 500,000
Mike:K? What's four or 5% interest on 500,000 versus 9% potential growth on a thousand bucks extra month? So you have to calculate the growth potential versus the interest going against you.
Mike:And there's an equilibrium that when your mortgage ends up being, like, I don't know, a 100,000, 200,000, and the amount of money that you could save, then it starts to shift to where you could start investing because there's not as much interest going against you. And people often miss this. They like to be in the all debt is bad camp or debt's how you you make money camp, and it's just not that simple. Mhmm. K?
Mike:So that's that's a general overall rule of thumb. Bad debt, pay it down quickly. Once that's done, then put as much money into the IRAs and the four one k's and so on.
David:Okay. Now
Mike:that said, this is the kind of the caveat of it all.
David:Alright. Okay?
Mike:Every year you're working, you're able to contribute to a Roth Uh-huh. And to an IRA. When you stop working, you can't, but there are limits. So you have to kind of balance. If you have credit card debt, you pay that off quick.
Mike:If you have an auto loan and you wanna pay it down quick, but you also could contribute to a Roth, maybe you max out the Roth contributions that year, and then the rest is an additional payment to pay down the auto loan faster.
Mike:You see, 19%, that's ridiculous. Get rid of it. 7%, you're kind of in this weird like, you you have a limited window. You can put money to a Roth. Yeah.
Mike:So you can kinda start to so this is now where you have the nuance of saving strategies in preparation for retirement. And there's different levels. There's really bad debt. There's bad debt, but you might balance between funding a couple of different places. Maybe you you don't just focus on debt, but you get the employer match, which is free money Mhmm.
Mike:Versus and then pay down your auto loan faster. Maybe there's a a loan on the house that something happened and you could like, you have to kind of bring context and compare what what the options could be. And then typically, the house the house is the trickiest one. Here's what I have found to be the truth. If if you retire and having a mortgage is gonna keep you up at night, you're gonna wanna pay down the house faster.
Mike:If you're okay having a mortgage payment, maybe for the first ten years of your retirement, but it's at a very low rate. Let's say you're locked in at the 3% rate or two four percent rate. Like, it's pretty low. Yeah. Then you might just keep keep making the payments and have your assets in the market where it can grow.
Mike:That's called positive arbitrage. It's a fancy word of basically saying, let's let's just say you've got a 100,000 left in your mortgage, and you've got a $100,000 of cash that you could do something with. Okay. And you're just having this debt conversation with yourself. Well, the $100,000 is probably gonna grow at a greater rate than the the debt.
Mike:It's not a guaranteed growth, though.
Mike:Right? So so you have to ask yourself, you can either pay it down at a sure rate, or you can put it in the market and hope it grows at a better rate. And if it does, then you made money dollar for dollar.
Mike:See, the young people, they don't they don't realize that this only works if it's a dollar a $100,000, you can pay it off or you can invest it. That's a dollar for dollar comparison. If you don't have a $100,000, that's your mortgage that's left, and you're just trying to look at the next thousand dollars to spend or to save or to invest Mhmm. Then you have to do a comparison on the interest against you versus the interest you could make with the money that you're saving.
David:I see.
Mike:So you don't wanna confuse the two in that sense. Okay. You want all conversations in finance to be within its appropriate context. Apples to apples, not apples to oranges. Mhmm.
Mike:And then we do have that fun if you wanna explore debt planning Mhmm. Debt payoff planning, freedebtplanner.com or retire on diamondcut.com. You can go to the debt planner. It's a fun tool. You can put all of your debts in there, and it will show you the fastest way to pay them down.
Mike:It will show you more emotionally, like, just pay off the smaller debts fast Mhmm. Faster. Great way to say, you know, I'm 40 years old. I'm 50 years old. I need to I need to get a a grip on my debt so that I can more intentionally save for retirement and be more proactive with it.
Mike:Dave Ramsey is right in the sense that debt is modern day slavery. Mhmm. It is predatory. It is ridiculous. Good debt, though, is not predatory.
Mike:It's just a risk assessment on you're being lent money at a reasonable rate. Yeah. K? And this is something I don't like. I'm gonna can I get on a pedestal for just a second?
David:Be my guest.
Mike:Many people have said and claimed that debt is against the Bible. It's not a Christian thing. Like, I I believe, like, there are some Middle Eastern religions or versions of a religion where they just won't touch debt. Love that idea. K?
Mike:And respect that idea. But in the Bible because that's what I'm more familiar with. K? Mhmm. In the Bible, in the Old Testament, debt is not against, you know, the the original doctrine.
Mike:What really is, it it talks about how predatory debt is not of God. K? K. But if if you have someone in need to lend them money at a reasonable rate Yeah. You can find that in Leviticus.
Mike:You can find that in Deuteronomy. Like, it talks about that, and that's the difference between good debt and bad debt. If you are trying to buy a house, that's a reasonable need to support your family. And at a four or 5% rate, that is a reasonable rate for what that would be. Now, do you make the minimum payments?
Mike:No. Maybe you should pay it off a little faster. Because you are now a, technically, a slave master relationship with the bank. Yeah. Kinda like, who's that guy that, like was it Jacob who once and was like a slave for ten years to marry the girl?
Mike:And then the guy was like, you know, forget about it. You have to be a slave again for another ten years because I'm gonna just trick you.
David:Oh, yeah.
Mike:Who was who was that? Is that Isaac? Is it Jacob? I don't One of the
David:One of those guys.
Mike:I'm embarrassed to forget in this very moment who that was.
David:I'm with you. But yes, I know
Mike:what you're talking about. I could pull the phone and we'd have it, but
David:Was he trying to marry a girl named Rachel or something?
Mike:Yeah. Yeah. We remember the girl's name without not the guy. Right. But but notice the relationship.
Mike:There was a there was a very clear contract for a specific reason Mhmm. That was negotiated. I think it is fair to either not have a house or you have a house and make reasonable payments, but you need to exert yourself to not be a slave for thirty years, you want to pay it off quickly.
Mike:So as the home appreciates in value, that's the goal, your money is still being well suited. The idea is if your home appreciates in value at the same rate that's going against you, it's not that bad of a deal. That's not predatory. Yeah. But to live off of credit card debt, that's allowing yourself to be taken advantage of, and that's the difference.
Mike:Debt is fine as long as it's done within reason. The problem is we get addicted to spending. We get addicted to, oh, I'm feeling pain. What's the fastest way out of the pain? Some people, they go to addiction.
Mike:Some people, they go to spending, which is a different form of addiction to alleviate that pain. Yeah. That and that's how you rack up credit card debt. It's trying to be paid before you've done the work. Mhmm.
Mike:It is an imbalance of an exchange, and that's why there's predatory. It's it's not that banks are evil, though in some sense, could argue that because they allow this to happen. Yeah. It's because there's so much risk on the bank for lending you money with no collateral. I mean, they have credit card debts with collateral.
Mike:Just no one wants them. Yeah. Because you have to put up the collateral to have that line of credit.
Mike:Right? So though the people people like this idea of no no strings attached, basically. Oh, you hit my credit score. Slap me on the rate. Mhmm.
Mike:So there there's a reason for those rates. They're not predatory in the evil sense. There's just it's an imbalance of the the negotiations, and you're paying for that imbalance if you don't pay off your credit card every single month.
Mike:So the hopefully, this has been a helpful conversation in what debt is okay, how do you handle it. Do you wanna pay it down? Yes. Is it good? Yes.
Mike:You wanna you wanna invest. You wanna max out your employer match if they have one. You wanna max out your Roth if you have it, but you also wanna be mindful of paying down your debts. And instead of ignoring all this and going on lavish vacations, you wanna find balance for you. You know, there's that that great book, The Richest Man in Babylon Mhmm.
Mike:Talking about Bible stories. Babylon's supposed to be like the evil guy. Well, anyway
Mike:But he talks about paying yourself first. You've got to pay yourself first, and a part of that is freeing yourself from modern day slavery or predatory debt. Yeah. Find balance in your cash flow.
David:And I think just to put out one last little bow on it, my my big takeaway is it's okay to have a little bit of debt if it means putting some money in your IRA.
Mike:I'd I'd focus on the Roth before the IRA.
David:Oh, yes. Okay.
Mike:But yeah. I mean, you when you're working, you can do that. When you're not working, you can't do that.
David:Oh, right. Okay.
Mike:So you just be mindful of of those opportunities, but find balance. It might not you know, it it I don't see, like, if you have credit card debt to wanna do your Roth and then deal like, you you wanna get rid of the high ones first.
David:Yeah. Yeah. Yeah.
Mike:But if you have lower, more reasonable debt, so like an auto loan at a reasonable rate or a mortgage, then you might say, we're gonna do 5,000 this year to the Roth and 5,000 to paying off the home a little bit faster. Oh. You know, whatever's right for you. Everyone's gonna have a different blend to this. But but taking advantage of getting money into a retirement account, and the reason is retirement accounts grow without capital gains issues.
Mike:Mhmm. So you can more appropriately, more aggressively, more strategically grow that money Mhmm. Without all of the consequences as opposed to trying to get it all in at the last moment. That there's there's limitations to it. Right.
Mike:So, you know, as they say, balance in all things.
David:Love it.
Mike:If you enjoy this show, make sure to leave a rating. Subscribe to it wherever you get podcasts or on YouTube. And most of all, tell a friend, the bigger the show gets, the more subscribers we have, the better the content will be, the more resources we're able to provide to you. As always, on retireontime.com, you can get the book, the workbooks, you can get the the cost of planning calculators. There's there's so many things on there.
Mike:Just go to retireontime.com to explore those resources. And as always, you're invited to join any of the workshops we've got going on where I actually create a plan live and answer your questions as I build. All of that, retireontime.com. Thanks for spending your time, your most precious asset with us today. We appreciate it, and we'll see you in the next show.