Debt Payoff Fanaticism vs. Investing

Last week we piqued your interest in the relationship between investing and paying off debt with our article about debt payoff fanaticism.  The core of that article was the simple question: “After you pay off your debt… well, then what?”

To drive it home (uhh… run it home?) we used a marathon analogy.  Paying off debt, from the perspective of, perhaps, the Permanent Income Hypothesis, is merely one stage in your relationship with money.  It is, perhaps, mile marker one in your journey along the 26.2 miles towards financial independence.  Whether you choose to ‘continue running’ at that point is up to you, but let’s leave it before we torture this analogy too much.

Consistency and Debt Payoff Fanaticism

It’s time for a thought experiment, roughly along the lines of the legal tradition of reductio ad absurdum, or “reduction to absurdity”.  If you are bullheadedly focused on the absolute eradication of all debt, it becomes near impossible to ever pick something to invest in.

Let me explain.  The fact is, it’s very hard to completely eliminate debt from consideration when you attempt to invest.

Do this simple experiment with me at the Zack’s stock screener.  First, in the ‘Company Descriptors’ tab, change ‘S&P 500′ to ‘EQUAL’ ‘YES’ and hit ‘Add’.  In the ‘Balance Sheet’ tab, change ‘Long Term Debt’ to ‘=’ ’0′ and hit ‘Add’.  At this point, hit the ‘Run Screen’ button.

When I ran that screen on 12/8/2013, I was left with only 31 companies.  I then double checked my list with Morningstar‘s excellent Balance Sheet history to eliminate a few misfiles and a couple who borrowed in their last quarter and was left with the following long-term debt free companies on the S&P 500:

 

Company Name Ticker
AKAMAI TECH AKAM
BED BATH&BEYOND BBBY
CHIPOTLE MEXICN CMG
COGNIZANT TECH CTSH
CITRIX SYS INC CTXS
EXPEDITORS INTL EXPD
FASTENAL FAST
F5 NETWORKS INC FFIV
FOREST LABS A FRX
GAMESTOP CORP GME
GARMIN LTD GRMN
INTUITIVE SURG ISRG
MICHAEL KORS KORS
LINEAR TEC CORP LLTC
LSI CORP LSI
MASTERCARD INC MA
MONSTER BEVERAG MNST
NEWS CORP NEW-A NWSA
PAYCHEX INC PAYX
QUANTA SERVICES PWR
QUALCOMM INC QCOM
RED HAT INC RHT
T ROWE PRICE TROW
URBAN OUTFITTER URBN
VISA INC-A V
YAHOO! INC YHOO

Note: this companies don’t necessarily have no long term liabilities, but they specifically don’t list ‘Long-Term Debt’.  So, deferred taxes, long term leases, pension obligations and the like may still apply.

And Why Do This Exercise?

Consider this – the person you have the most control over… is you.   You control exactly how your debt is going to be paid, taking into consideration the terms of the debt you took out.  No matter how safe the debt of others may be, historically – whether they be company debts, or even debts from, say, the US Treasury, they’re still more out of your control than your own debts.

Yes, it’s a very important lesson – if debt zero is incompatible with you handling your own debts, no matter how inexpensive (say, a cheap 30 year mortgage for well less than area rent), then it’s certainly incompatible with trusting other people with debt.  Like Milton Friedman said, efficiency in spending decreases in this order:

  1. You Spend Your Own Money on You
  2. You Spend Your Own Money on Someone Else
  3. You Spend Someone Else’s Money on You
  4. You Spend Someone Else’s Money on Someone Else

Companies issuing debt?  They’re class III.  Spending your own money on debt?  Well, that’s a I.

For most investors, they understand that some debt is safer than others.  However, if you don’t trust your own debt, it is impossible to rectify that with ever investing in the debt of something else.  Stated simply: if you are of the debt-zero slant, why would you buy other debt, such as company or government debt, before taking out your own?

What’s the Takeaway?

For starters, maybe I’ve got debt-zero folks wrong.  Personally, I weigh my debt as any other investment, and will gladly invest in companies which issue plenty of debt (at the right cost!).  However, this isn’t a story about me, it’s a story about the extremes of personal finance advice.

The point, again, isn’t to insulate yourself and solely concentrate on a clean balance sheet on the ‘debt’ side.  You need to look at your debt and your potential investments on a scale – debt is really just an investment with a known return.  By unifying your thoughts on investments and debt, you’ll have a much clearer goal in mind – because, yes, “what’s next?” is hard to answer.  If you look at everything on the same line… well, that question will answer itself.

And, yes, you’ll realize that your 401(k) match should almost definitely be prioritized over that 1.49% car loan.  Please read the last article for the full problem description, and happy running!

Disclosures: Nothing mentioned owned outside of the incidentals in mutual funds.

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Comments

    • says

      Luckily (?) for me, I don’t have that moral hangup – sure, I have my own pricing for risk, but I wouldn’t back off something because I’m devoted to debt paydown at all costs.

  1. AvgJoeMoney says

    Brilliant. I hope you talk about this on the podcast. I think you do have the zero debt crowd wrong (slightly) but if you’re going to practice what you can an “ideal” practice, you should follow it through. I love the video, too. Great stuff.

    • says

      Maybe, but I haven’t seen any evidence I’ve got it wrong – especially when it comes to paying down mortgages and building emergency funds. To me, it’s hard to rectify that with buying the debt of another entity. Call this my “confused piece”, perhaps?

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