The Four Pillars of Personal Finance

Both my co-writer Cameron and I have recently penned screeds on a worrisome trend we’ve seen in Personal Finance blogs – the hyperbolic obsession with “Debt Zero”.  “Debt Zero” is, of course, the idea that above all else Debt Must Be Paid Down (or avoided entirely).

The first clue that something is  wrong with that story is the inclusion of the word “must”.  There are very few absolutes in life, (the snarky amongst you will acknowledge death and taxes) and this situation is no different.  You see, it’s naive to assume that avoiding debt comes for free.  Remember: every decision you make is a trade off.


This Gold Pillar Seems Appropriate!

Opportunity Costs

That’s right – everything has a cost.  In particular, that cost is measured as the next best alternative to what you do with any resource – be it time, money, caloric intake, or whatever limited quantity/resource that you have available.  For example, if you stopped reading this article and started watching cartoons, you could very well be hurting future net worth gains that you could have made by taking the conclusions in this article to heart.  This concept is known as “Opportunity Costs“.  So, when we are talking about the topic of Personal Finance, any move we make should be weighed against the alternative.  Consider these two scenarios:

  1. You are spending more money than you bring in monthly.  One way to use your time is to extreme coupon, lowering your spending to less than your income.  However, consider there is a flip side – you can pick up more hours working, increasing income and giving you that same net cash flow.
  2. You come across $100,000, and you currently have $100,000 in debt.  You can either pay down the debt or invest your windfall.

So, let’s talk about the four pillars of personal finance:

  1. Assets – Assets, when we talk about personal finance, are anything which can be converted into money.  You decide how far you want to go here – your car, your house, your investments, your kidneys?  No – your winning smile doesn’t count, although it might help you earn more.
  2. Debts – Money you owe to outside entities.  Your IOU to your father, your mortgage, your credit card bills… those are all debts.  You have some agreement as to how that debt is structured, but you will have to meet the terms of the contract with future income or assets.
  3. Inflows – The speed at which you accumulate things of value.  This is usually money, but if you are paid with gold or trading cards, the same idea applies.  Since you can convert those to cash (see #1), these count as inflows.  The most popular ways to measure this are “dollars per year” or “dollars per month”.
  4. Outflows – The speed at which you spend or use things of value.  Again, usually money – but if your employer fills your gas tank or gives you a pile of food, it could be a good.  This is also usually measured as dollars per month or year.

The Only Two Equations That Matter

(In Personal Finance!)

Cash Flow = Inflows – Outflows

Net Worth = Assets – Debts

Our problem?  There is way too much concentration on one variable in just the second equation (for those of you who are just skimming the article, debt).  If you can increase Assets faster than you can increase Debts?  Guess what – you just increased Net Worth.  Likewise, both spending less and earning more can increase cash flows.

So, don’t let opportunity costs get you.  Know what you’re missing out on when you make a financial decision.

Okay, you can watch cartoons now.


  1. JT says

    I don’t latch on to the idea of “comfort” from an unlevered balance sheet, but I can somewhat understand the idea of favoring “debt zero” if your only experience with debt is absolutely 100% negative.

    I side with you, though. As long as assets are increasing at a rate faster than debt, and with each new debt you add cash flow in excess of the servicing costs, you’re winning the game. This is just one of the many reasons why I think corporate finance (not necessarily personal finance) should be taught in high school. If you can understand it on an impersonal level, you can certainly understand how the concepts relate to your own income statement, balance sheet, and statement of cash flows.

    • says

      Glad to have you on the side of reason (heh), but I do want to say I completely agree… Happiness is not an empty balance sheet.

      Paying off your consumer debt is just one hurdle in a long race to financial independence. Way too many people concentrate on just that first hurdle.

  2. says

    Hey PK,
    I enjoyed the article. I would agree that anytime somebody says you “must” do something, you should be suspicious. However, I also think that you should be suspicious about anybody who is trying to sell you something. Somebody is going to be making money off of your investments. Nobody really benefits from paying off debt but you. That is one reason most “financial professionals” will tell you to invest rather than pay off your debt.
    Furthermore, what many people to fail to include when they promote investments over debt pay off are A) risk factors and B) fees/taxes. We should all know that there is an inherent risk involved anytime that we invest money. Yet, we forget to factor that into our equations. Furthermore, if you don’t pay off your debt first, you are essentially borrowing money to pay for investments. Most people I know wouldn’t take out a loan in order to invest it in the stock market. However, that is essentially what they are doing if they don’t pay down their debt first.
    While I don’t subscribe to the “you must pay off debt before you do anything else” manifesto, I do fall nearer to that than the “invest over debt payment” crowd. Personally, we are doing both. We save for retirement at a rate high enough to earn the employer match. We then use the rest of our cash flow to snowball our debt. In fact, we did receive a windfall and paid off our consumer debt. I have absolutely no regrets about doing that. I know that I won’t have any regrets about paying off our house early either.
    I never realized how suffocating debt can be until I got out from underneath it myself. We have so much more money to work with now that we don’t have to shell out hundreds of dollars a month in car and student loan payments. We can live now while still saving for the future. It really is a freeing feeling.

    • says

      “Just because you’re paranoid doesn’t mean they’re not out to get you.” – that pretty much sums up my attitude with all voluntary agreements (and it’s not limited just to picking out investments). I definitely agree with your general warning to ‘follow the money’ when you evaluate where to put your money.

      However, counterpoint… Your creditors also benefit from you paying off your debt. You see, depending on the type of loan, there is a certain risk built into the price on the creditor’s end since a certain number of loans will become worthless. Cameron can go into much greater detail on this point (it runs pretty close to his day job), but since not all loans will be paid off, you paying off your debt is a net benefit to the lender of your money.

      All that said, I don’t necessarily think it’s a bad thing that there is more than one set of hands with palms facing the heavens every time you go to invest. It is someone’s job to run investments – whether it’s bank certificates of deposit, treasury notes, mutual funds, or even individual stocks (the company’s management). So I’m not necessarily turned off by someone making money at the same time I do, so long as the return to me is ample for the amount of risk I perceive in ever getting my money back.

      I think that left unsaid is a simple point – that, for you, the value of security is worth more than the chance of some return. Because, yes, freedom from volatility and security is worth something (especially as you get closer to retirement, or if you have previously had a bad experience). So perhaps you have a loan you’ll pay off at 5% even if you know some investment has a good shot at earning 8% – you value the guarantee of return more than the potential shot at alpha – and that’s your decision to weigh and make. That’s strictly from an investment perspective – I have some articles in the queue about some particular situations that you’ll find interesting (and I don’t mean to suggest you should regret paying off your debt with the windfall).

      Now onto your point about investing while in debt – there are many examples of companies and people I can point to that have been successful with that strategy. I work in tech (check out the balance sheet on pretty much any Fortune 500 tech firm – lots of cash and lots of debt), but take a look at banking – the entire industry is based on the money you can make lending out money (cars, houses, credit cards) at a higher APR than you borrow (savings accounts, certificates of deposit, etc.) For an individual there are places to capture that spread too – an easy example would be refinancing a home to a lower rate, even if it meant rolling closing costs into a loan. It might also mean taking out consumer debt for a business idea, taking out a student loan for college, or even on the very specific front capturing the difference between a free balance transfer offer and FDIC guaranteed returns.

      And on the mortgage front – sure the S&P 500 has gone through rocky periods (you can see our S&P 500 calculator here), but I still like my chances better in the stock market than the roughly 3% benefit I’d get from paying off my mortgage.

      • says

        Unbelievable PK! You always find ways to point out things that I otherwise never would have thought of. From the standpoint of a borrower, or somebody in debt, you never think about it from this point of view. “Your creditors also benefit from you paying off your debt.,.. since not all loans will be paid off, you paying off your debt is a net benefit to the lender of your money.”

        As a recent investor over at Lending Club, you would think I would have thought of that. Loans that go into default have a direct effect on my overall rate of return.

        • says

          Haha, yeah, I didn’t think of peer to peer lending but you’re absolutely correct. Here’s a funny one – if one of your friends or family borrows from you it certainly helps you when they pay you back… unless you were using the ‘loan’ as a cheap way to buy off not having to talk to them anymore?

  3. says

    Good stuff! I have to say I’ve been far less concerned with my debt lately, now that it’s manageable, not accruing interest and smaller than the other variable in the equation. Unfortunately, this is making my blog name slightly less relevant. But I am still interested in the general idea of living without incurring consumer debt, so it stands for now.

    • says

      Haha, you should have planned on successfully making your blog name no longer make sense (insert cents joke here).

      I have mortgages and I have student loans. I also have stock & real estate, and a positive net worth. My thoughts on consumer debt are quite long, but I have written an article about my credit card strategy. You know, because I don’t use them like ‘credit’ cards.

  4. says

    Although.. it seems to me that getting control of the ‘debt’ part of the equation will have the greatest effect on the other variables in both equations. Less debt equals less outflows equals greater cash flow which leads to investing in more assets which leads to greater net worth. But then again, Donald Trump found a way to maximize on both of these equations while using debt as a tool. Another great article PK!

    • says

      Fair enough. But let’s say you first come to DQYDJ deep in debt. 7 figures, crazy debt even.

      You pay it off.

      Then what?

      That’s why I’m trying to push a bit, haha. It’s like you’re (the ‘royal’ you) in a 100 meter race, you took 10 steps back, and you’re all worried about going back to the starting line. Then what?

  5. freeby50 says

    I think a lot of personal finance blogs focus on debt a lot because high debt levels are a problem for both the bloggers and readers. Many of the blogs start by discussing their own giant pile of debt and their journey towards a positive net worth. Many readers are in the same boat. So I can understand why theres a lot of focus on debt. If you look at the average Americans finances then cutting debt is a good idea for most, so it makes good sense to start there. But yes, some go too far with the ‘debt is slavery’ nonsense.

    • says

      “Debt will enslave you!” <– sounds like a good plot for a Hollywood blockbuster spoofed by The Onion.

      I sort of fleshed out my feelings to Matt, but I'm serious… once you pay it off, then what? I don't know a situation where once you pay off your consumer debt suddenly you're 'done". I consider this my more holistic look at the big picture – since you retire (or even just achieve financial independence, if that's your goal) based on net worth, not whether you have achieved "debt zero".

      Also, I'm probably not the best person to explain the whole 'debt blogging' thing. Yeah, I had a ton of student loans (and still have more than many of the debt bloggers, ironically), but they didn't keep me up at night.

  6. says

    “if you stopped reading this article and started watching cartoons, you
    could very well be hurting future net worth gains that you could have
    made by taking the conclusions in this article to heart” — LOL! That’s quite the confidence! :-)

    Thanks for speaking the message I’ve been thinking for a long time … I think debt-zero can be a short-sighted strategy. Now, I understand that debt = risk, and some people may want to lower risk by lowering debt. But at the same time, there’s a difference between using a moderate amount of leverage and being totally debt-free (and that difference, as you say, is opportunity cost).

    How much is “moderate”? I’ll give the ‘ol investing answer that it depends on your risk tolerance :-) For rental properties that cash-flow positively (the investing arena about which I know the most), I’m comfortable with the assets that I control being 3-5x higher than the bottom line on my balance sheet. Beyond that, my risk tolerance gets squeamish. Some RE investors would leverage 10x and they’d call me conservative. The debt zero crowd, obviously, would call me risky. Moderate is in the eye of the beholder, I suppose.

    • says

      Ha, it ‘could very well’ be confidence. Or biting sarcasm. Your call.

      Right – debt zero is totally short sighted, that’s the best way to put it. After debt zero, what then? Even if you get to zero you need to put in a ton of work to reach independence or retirement – then what? That’s the much harder stage.

  7. Simply Rich Life says

    That relates well to a perspective I like to use, which seems to be uncommon. Being wealthy is the product of earning more than you spend (inflows and outflows) and feeling poor is the product of wanting more than you have (assets and debts). It’s the difference that counts more than the actual numbers. There is no “right” number without looking at the context of the others.

    Unfortunately many people start off with large debts from education, housing, and sometimes shopping, when they are young and inexperienced. Then if they follow the standard financial plan they retire with no debt once they have a lot of experience and hopefully some wisdom and assets. This backwards arrangement leads to mistakes, misdirection, and the perception that it’s better to avoid all debts. Financial planning would be much simpler and common sense would be much more reliable if we could re-arrange the timeline of our finances.

    The only people who can ignore everything other than their debt are the ones who have a very good pension plan.

    • says

      I have (or used to have) 2/3 on your list – student loans and fat real estate debt. Consumer debt on the other hand? Well, it resets to 0 every month, heh.

      I think that youth is wasted on the young though – I’d definitely choose my path again and suffer through tougher courses to end up where I am today. I’d probably try to convince a few other to stick with it too (CECS happens to be a heavily dropped major…). Debt aside, the permanent income hypothesis probably explains a lot of it – if you think you can earn more in the future (say, as a college student earning net -$40,000 a year…), you’re liable to take on more debt. Perhaps we just need to let our children know what they can expect to earn?

      • Simply Rich Life says

        It’s hard to know what you can expect to earn, unless you take out a massive student loan and you’re restricted to a very narrow job search just to be able to pay it back (and you’re qualified in that job market, and that job market still exists when you graduate, and the industry doesn’t go down in flames shortly after you start). We have a better chance of informing our younger selves than being able to tell our children exactly what they will earn :)

        • says

          Fair enough – and you need to factor in the region you’ll be living in too (I make more as an engineer in the Bay Area than I would in Route 128/Boston, although I pay for it with cost of living). However, I do think you can get a general idea, and we’re pretty bad at informing the generation. For example, how many English majors, before they graduate, understand Pharmacists will make a lot more?

          • Simply Rich Life says

            You can’t guarantee high earnings, but you can guarantee low earnings. Somehow that message got lost.

  8. says

    There are some more pillars of Personal Finance but shared Assets, Debts, Inflows and Outflows are basic. In my personal finance debt does not come. As i don’t prefer any types of debt of basic living needs or leading a luxury life.

  9. Alexander Davis says

    If you run your personal finances like a business, Assets, liabilities, cash flows, income statement. Then you will quickly understand how certain kinds of debt can leverage your return on your assets.

    For example, fixed rate 2.99 fixed debt invested in diversified funds with a long term outlook? I don;t care how gloom and doom you are I am confident in overcoming 2.99% returns on my investments.

    Hell if rates go above 3% the government/inflation is paying part of my loan for me!

    If businesses applied the zero debt theory they would severely hamstring their growth.

    • says

      I’ll raise you one – in the current environment, I’m wary of seeing no (or very low) debt and tons of cash equivalents on a balance sheet – *cough* Apple *cough*.

      • Alexander Davis says

        I agree, apple should distribute more, there is a limit to how much R&D investment they need and that capital could do a lot of good in other industries in society, flowing to shareholders into other investments.

        Major acquisitions don’t make a lot of sense for apple as their size and culture would create problems. Small tech acquisitions make sense but require drops of their cash to achieve. They should just start Apple Capital Inc. and make a huge fund, return profits from that and Apple Operations to shareholders, lots of options.

        • says

          Even small investments are hard in tech right now. I can’t get too specific due to my day job, but note the number of sales – many, spread far an wide, and a lot of sales of foreign branches (aka non-repatriated money).

          There are a number of large tech funds with Capital Investment groups. Returns are hard to find right now though – witness the pressure that even Warren Buffett is coming under to issue dividends(!).