Yearly net worth
- Thread starter dmclone
- Start date
You buy a $3,500 Buick with 95,000 miles on it that will run another 100,000. It's not pretty or styling, but it gets the job done.
New cars are one of the biggest mistake people make. They think they have to get the latest, greatest and they blow $20,000 plus on something that depreciates to nothing. At least with a house you should have some value at the end.
My brother(who probably makes six digits as a engineer) never has paid more then $5,000 for a vehicle. He has a Ford Ranger he's driving right now that he bought with 118,000 miles on it and he's up to 270,000 and hasn't stuck much into it. He thinks it's funny that most of the people who work under him feel the need to drive new vehicles. And then to top the cake with a cherry, they complain about not having any money!
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Ramsey Step 6 here.
My dad always said, figure out how to have people write checks to you, not the other way around.
To me, paying off all debt is how I achieve that. I drive junky cars but then pay cash for a nice car for my wife.
My dad always said, figure out how to have people write checks to you, not the other way around.
To me, paying off all debt is how I achieve that. I drive junky cars but then pay cash for a nice car for my wife.
So you're working for the wife, just like the rest of us!!:biglaugh::biglaugh::biglaugh:
I have never believed in Ric Edelman's teaching because he conveniently fails to account for risk.
Edelman declares you should never prepay your mortgage and you should carry the largest mortgage you are able. This is primarily because the ROI is greater for funds invested in other financial vehicles, such as equities, than you would realize if you paid down your mortgage. This is flawed analysis as it fails to properly account for risk.
Example: Say you take out a 30-year mortgage at the current national rate of 5.5%. After considering the interest deduction on federal taxes, the effective rate is 4.125% (assuming a 25% marginal tax rate.) Therefore, a 4.125% return is required to break even, and a greater return is necessary to justify the investment. Where to go for these returns?
In this scenario, you can obtain return of 4.125% with no risk (essentially), or 6.20% return for stock market risk. Edelman would suggest that you take on stock market risk for a net return of only 2.075%. In this case, the risk-adjusted return is actually higher for paying off the mortgage.
This may warrant more explanation but I have already exhausted way too much space with this post.
Edelman declares you should never prepay your mortgage and you should carry the largest mortgage you are able. This is primarily because the ROI is greater for funds invested in other financial vehicles, such as equities, than you would realize if you paid down your mortgage. This is flawed analysis as it fails to properly account for risk.
Example: Say you take out a 30-year mortgage at the current national rate of 5.5%. After considering the interest deduction on federal taxes, the effective rate is 4.125% (assuming a 25% marginal tax rate.) Therefore, a 4.125% return is required to break even, and a greater return is necessary to justify the investment. Where to go for these returns?
- U.S. Treasuries - 2.8%
- Municipal Bonds (single A rated) - 4.63%
- Corporate (single A rated) - 5.84%
- US. Equities - 10.37% (historical compounded rate of return)
In this scenario, you can obtain return of 4.125% with no risk (essentially), or 6.20% return for stock market risk. Edelman would suggest that you take on stock market risk for a net return of only 2.075%. In this case, the risk-adjusted return is actually higher for paying off the mortgage.
This may warrant more explanation but I have already exhausted way too much space with this post.
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Good article, but I think the time frames quoted for the returns are too short. Stock returns actually are closer to 7 or 8% over say a 70 year time frame. No gurantees that will continue either...
I focused on paying down debt and investing in the stock market over the last 10 years. As of today, the stock investment has returned about zero while the equity build up on paying down debt is looking much better.
Over the long haul, I agree stock is the place to be. Debt reduction also has it's place however.
Actually it is not an article, I just pulled some numbers together and made the calculations. I pulled the stock returns from Vanguard, and I believe the time frame was 1926 to 2005. Keep in mind that the 10.37% return is not adjusted for inflation and the calculation is compounded returns, not annual rate of return. If you want to consider annual rate of return, the number is closer to 7% over the last century. The real rate of return is even lower due to inflation over that time period.
I believe the numbers I presented are supportive of paying down mortgage debt due to the risk-adjusted return calculations. I have not, and don't plan to, calculate the Sharpe ratio, but the numbers are supportive of paying off mortgage debt in the scenario provided.
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I guess my thing is, how much money do you need? I plan on having my house paid off by the time I'm 40 and based on the schedules my wife has calculated for our investments, we'll have more money then I'll know what to do with by the time we retire. I guess for me I'd rather live half my life with no debt burden and still have plenty to live on as opposed to absolutely maximizing my earning potential and still having more money than I'll know what to do with.
You nailed it. Why do some people work 80 hour weeks and they have more money than they could ever spend during their lifetime? Personally, I could earn more if I were willing to relocate but quality of life means more than earning every last penny possible.
I have to respectfully disagree, at least in part, with some of these claims.
A-Gives up a tax advantage
It does reduce a tax deduction, but concurrently reduces debt service. You are paying interest to reduce taxes by carrying a longer term mortgage.
B-Has no hedge against inflation
Generally, the "return" obtained reducing debt is about 3.675% on a 15-year mortgage after considering the tax deduction at the 25% federal bracket. This is above the 10-year average inflation rate.
C-Has no rate of return
The rate of return is the reduction in interest paid to debt service. See above example and previous post.
D-If you get disabled you can't use it
I assume you mean you cannot use the money paid against the mortgage whereas you can utilize the funds in an investment However, consider that your actual assets have not been significantly reduced, only the liquidity is impacted. Home equity can still be accessed, albeit less freely.
Philosophically, I believe that leverage should only be used when a greater risk-adjusted rate of return is expected on the investment made with the borrowed money. To limit the discussion to personal debt, there are few opportunities where a person should take on leverage personal purchases. For example, a vehicle, while necessary for most, depreciates rapidly and does not generally have a positive rate of return. Thus, it does not provide a case for taking on debt. A home is not as clear on the surface, but the numbers suggest that while you may get a numerical advantage from the Edelman plan, the added risk does not support the plan from a risk-adjusted standpoint.
Further, consider that the mortgage is on your home. It is one thing to put your business and business assets at risk to achieve returns, it is another to put the place where you live at risk. I am not completely debt-adverse, but I only take risks with my business, not my personal finances.
Okay, we're on the same page then. I agree! Hat's off to a very eloquent and well thought out response.:notworthy:
If you read Dave’s books and listen to his programs, he is adamant that you follow his seven Baby Steps in exactly the order that they are written, and you may not move on to the next step until the first is completed. While this makes for an orderly approach and is good for those who crave organization, it can cause some problems. Just to review, the Baby Steps are:
1. $1,000 to start an Emergency Fund
2. Pay off all debt using the Debt Snowball
3. 3 to 6 months of expenses in savings
4. Invest 15% of household income into Roth IRAs and pre-tax retirement
5. College funding for children
6. Pay off home early
7. Build wealth and give. Invest in mutual funds and real estate
According to Dave, until you have all your debt paid off, you shouldn’t be saving for retirement. But this ignores the value that compounding interest brings over time. Even if you’re funneling most of your money to debt payments, any little bit that you can put towards retirement will grow much larger in the future. His idea for a $1,000 emergency fund isn’t bad, but in this day and age $1,000 isn’t going to cover many emergencies. You need a bigger fund than that, but you can’t start building it until all debt is paid off. Until then, if you have a big emergency it’s going to have to go on a credit card, putting you further in the hole.
Why can’t there be a compromise between directing large sums of money to debt, but also putting some in savings and toward retirement? Just like a crash diet is a shortsighted approach to losing weight, Dave’s plan is a shortsighted approach to getting control of your finances. His plan focuses too much on getting the debt down as fast as possible without looking at the larger life that you must also prepare for. Paying down debt is a fine goal, but there are other contingencies you need to prepare for, as well.
1. $1,000 to start an Emergency Fund
2. Pay off all debt using the Debt Snowball
3. 3 to 6 months of expenses in savings
4. Invest 15% of household income into Roth IRAs and pre-tax retirement
5. College funding for children
6. Pay off home early
7. Build wealth and give. Invest in mutual funds and real estate
According to Dave, until you have all your debt paid off, you shouldn’t be saving for retirement. But this ignores the value that compounding interest brings over time. Even if you’re funneling most of your money to debt payments, any little bit that you can put towards retirement will grow much larger in the future. His idea for a $1,000 emergency fund isn’t bad, but in this day and age $1,000 isn’t going to cover many emergencies. You need a bigger fund than that, but you can’t start building it until all debt is paid off. Until then, if you have a big emergency it’s going to have to go on a credit card, putting you further in the hole.
Why can’t there be a compromise between directing large sums of money to debt, but also putting some in savings and toward retirement? Just like a crash diet is a shortsighted approach to losing weight, Dave’s plan is a shortsighted approach to getting control of your finances. His plan focuses too much on getting the debt down as fast as possible without looking at the larger life that you must also prepare for. Paying down debt is a fine goal, but there are other contingencies you need to prepare for, as well.
I don't know who Dave is, but given the tax benefits and employer matching [often] available for contributing to a 401k, this is incorrect advice. The exception may be if the debt is high-interest credit card debt.
And you are ignoring the psychological element. Getting out of debt has nothing to do with math. It has everything to do with psychology. And someone who is deep in debt usually got there due to misbehavior. You don't teach a drunk to get sober by decreasing the amount they drink, do you? You teach them how to quit. And if you are serious about the method, you will pay off your debts extremely quickly, and really not miss out much. And debt compounds just like investments do.
It's called a "baby step" for a reason. $1000 is a quick win, and breaks the vicious cycle of going into debt every time the cat sneezes.
Because people don't work that way. The compromise you speak of slows down the process and the slow process will cause people to drop the program.
I'm just wondering if you have a point here, except to make a false analogy to support your straw man attacks on Ramsey's method, which incidently contradicts your world view.
I would suggest you read more of Ramsey's stuff to see exactly how longsighted it is. It is nothing close to "shortsighted."
BTW - I lost 70 pounds two years ago rather quickly and kept it off. Mainly by being intense. With intensity, you can lose weight safely and keep it off. Just like you need to be to follow Ramsey's method.
