Losing Interest

Jonathan Clements

“ONLY BORROW TO BUY things that’ll appreciate in value.” This was a popular piece of financial wisdom in the 1980s, when I started writing about personal finance. But I can’t recall anyone saying it in recent years. Does that mean this wisdom is no longer wise?

Financial habits have obviously changed. I might make just a single cash machine withdrawal each month, because I put almost every expenditure on my two credit cards, which I use to buy groceries, gas and restaurant meals—none of which has lasting value. Still, this is short-term borrowing that benefits me: I pay off the card balances as soon as the bills arrive, so I don’t incur any financing charges, while pocketing the credit card rewards and enjoying the convenience of using plastic.

What about longer-term borrowing? According to the Federal Reserve Bank of New York, U.S. consumers were $12.1 trillion in debt as of year-end 2015. Mortgage debt accounted for 72% of the total, student loans 10%, auto loans 9% and credit card debt 6%.

With any luck, the mortgage will buy a home that appreciates in value and the student loans will increase income-earning ability. The car, by contrast, will almost certainly depreciate. But the car—or, at least, the version without leather seats—is also an economic necessity for many folks, who otherwise couldn’t get to work. Thus, it seems the vast majority of debt is indeed taken on to buy items that appreciate or have some lasting value.

But even if most money is borrowed for a good reason, it doesn’t necessarily mean borrowing is a good idea. Why not? First, the interest rate on our debts is typically higher than the interest we can earn by buying bonds, money market funds and certificates of deposit. This is true even for tax-deductible mortgage debt. The implication: To pay for our next major purchase, we should be less inclined to borrow—and instead sell conservative investments held in our taxable account.

Second, we shouldn’t borrow any money we can’t repay by retirement. Unfortunately, an increasing number of folks are quitting the workforce still burdened by debt. This isn’t smart, and not just because it boosts the cost of living for these retirees and makes their finances more precarious.

With no paycheck to service their debts, retirees will need to dip into savings—and they could find themselves drawing heavily on individual retirement accounts and old 401(k) plans, with every dollar withdrawn taxed as ordinary income. Those retirement account withdrawals could, in turn, trigger taxes on up to 85% of a retiree’s Social Security benefit.

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