Harold Winslow

Debt is Just a Bill

Net worth is a misleading metric.

Suppose you have student loan debt or a mortgage. I pick these examples because they may be quite large debts, upwards of $100K, and are debts that rational people in good financial standing might acquire (which is not the case for ordinary consumer debt). Say that your debt is $250K. What exactly does this mean for your financial situation?

Well, it means that you now have a monthly bill for $x for some period of time - you have added a recurring expense to your budget. That is all. Your debt is roughly equivalent to having a dog, which requires regular expenses for food and vet visits but, after a period of time, ceases to be an expense. But do you think that your dog counts as a debt? Do you subtract your future dog expenses from the value in your brokerage account and ascribe meaning to that number?

Some more examples. If you currently rent, have you subtracted the value of your next 30 years of rental payments from the sum of your savings? If you are currently putting yourself through school, paying as you go, have you already subtracted the future tuition payments you'll make from the value of your assets to assess your financial status? The answer to all of these questions, I hope, is no.

The whole function of loans is to amortize the cost of a large expense over time. The fact that you are obliged to pay the expense eventually does not mean that it is useful to aggregate the value of your monthly payments into a current total liability, unless of course you just want to cover your full obligation right now.

If you are calculating your net worth at all, it is probably because you want to know if you have enough money to retire on. And if you are answering that question you might be misled if you simply subtract liabilities from assets instead of treating your liabilities as the recurring cost that they are.

Say you are going to follow the 4% rule and that your annual expenses, including debt payments, are $40K, so that you need $1M in assets to retire. If you already have $1M in assets but also have $200K in student loans to pay, you may trick yourself into thinking that you need to save $200K more before you can retire. But if your student loan payments are already baked into your annual budget, then you have nothing to worry about! Debt is just a bill, like any other recurring bill. It's better not to have it, but it's probably not as bad as you think.