The Dangers of Being Debt-Averse. Really.
At a time when many Americans are still overextended on their credit cards, straining to make their mortgage payments and weighed down with student loans, wealth manager Thomas Anderson is focused on a unique minority -- people who don’t have enough debt.
Anderson, 38, argues in his new book, “The Value of Debt: How to Manage Both Sides of a Balance Sheet to Maximize Wealth,” that too little debt can be dangerous. His target audience is people with some wealth who, he says, mistakenly make paying off debt their first priority. Here are edited excerpts of the former investment banker’s conversation with Bloomberg’s Ben Steverman.
Steverman: A lot of personal finance experts essentially argue that debt is evil and should be paid off as quickly as possible. What’s your perspective?
Anderson: There’s this huge disconnect between the way companies think and the way individuals think. Companies have a clear debt strategy. You could fill a library with books about the optimal corporate capital structure. Nobel Prizes have been awarded on that topic. Very few individuals approach debt with the same philosophy. People tend to be way too overlevered or completely debt-averse. I try to frame for people what’s optimal.
Five years ago, we went through a period when a lot of people were clearly overlevered. Why write a book now advocating the use of more debt?
The problem with a lot of popular authors is they coach people so much on paying down debt. But many people don’t have enough liquid cash reserves. For a tremendous number of people, 2008 was a liquidity crunch.
What do you mean by liquidity, and why is it so important?
Let’s say you have a $500,000 house and a $400,000 mortgage. I give you a $100,000 bonus and you use it to pay down your mortgage. You feel like you’re doing the right thing. You’re paying down your debt.
And then, bam, you lose your job. How much money do you have in the bank right now? Zero, because you just put it all in the house. Also, you have to keep making that mortgage payment. After a short period of time, you can end up going bankrupt – even though you did the right thing by paying down your debt.
If instead you put that $100,000 in a globally diversified portfolio, you could have kept making those debt payments, you could keep your house, you could look for a job. People don’t understand the flexibility that you have when you have money in the bank rather than rushing in to pay down debt. Especially debt that has a low cost of capital associated with it, like mortgage debt.
Is there an optimal debt level for individuals?
I believe that 15 to 35 percent [of total assets] is an optimal range. That may or may not be appropriate for all people. Seventy-five percent of America would have to massively de-lever if they read my book.
Right, because individuals usually evaluate their debt by comparing it to their income, not their assets. You’re really writing for people who have substantial wealth already.
If you have less than $250,000 in liquid investable assets, you really can’t implement a lot of the ideas in the book. I’m really gearing this toward baby boomers who are approaching retirement. A lot of them are rushing in and paying off their debt. The consequence of that is they’re losing liquidity.
How do you distinguish between good debt that you should keep and debt you should pay off?
Debt that’s tax-deductible with a low interest rate has the best potential to be “good.” Debt that’s not tax-deductible with a high rate is the debt that you should be paying off.
You say one of the main functions of debt and credit lines is to be there in an emergency, and that people should open up a line of credit at their brokerage firm.
There’s zero downside to having it in place. There’s no cost to open the line of credit, and there’s no cost if you never access it. All that it does is increase your flexibility. And, as it turns out, 90 percent of clients who are eligible don’t do that.
We could all have emergencies. We could need to lend to children or provide a bridge loan to elderly relatives moving into care facilities. When disaster strikes, insurance companies don’t say “here’s $200,000, spend what you need and send back the rest.”
If we move down the income ladder, does any of this apply to student debt?
When they’re shortly out of college, a lot of people rush to pay off the debt. But they don’t have the liquidity they need. If you’re unemployed for six months, that shouldn’t surprise you. It happens to lots of people within the first 10 years of employment. You need to make sure you have liquidity to ride out those storms.
Some college debt is structured with incredibly low rates, because it’s effectively subsidized. (Other college debt is at horrendous terms.) You could be in a better position by leaving some debt in place so you build up your liquidity, so that you can ride out storms.
Now you’re making me feel better for dragging out my graduate school debt over 20 years. I see your point – as long as I’m saving in other ways and not just spending it on luxury goods.
My book is not about taking the extra money and buying a Maserati. It’s about taking that extra money and saving it and building up that liquidity. It’s a question of 'Am I going to pay off debt or save it?' It’s not a question of 'Am I going to pay off debt or go to Disney World?'
Behavioral economists might take issue with your approach. Theoretically, there might be an optimal level of debt, but many people get carried away. The more access to credit they have, the more they spend.
I start with the premise that you are rational and disciplined. Many, many people do not have the discipline to behave rationally with these approaches. If that’s the case, you need to throw out my book.