How is your Relationship with Debt?

I’m writing this shortened newsletter from my in-laws house in Vineland, Ontario. It was our first flight with our 7-month old son and it went about as good as it could go. He was the source of entertainment for many rows around us and only got upset when the air pressure changed on landing. Who wouldn’t be upset with this scenario? He is a very happy baby and his moods are wonderful, until they’re not. That also describes the relationship that households and corporations, even governments, have with debt. Like my son, debt will be your friend… until it isn’t.

Legendary investor Howard Marks posted a memo in the last few weeks with the topic, “The Impact of Debt”. I would urge everyone to read his memos, they only take 5-10 minutes to read, and they are packed full of wisdom. The one section I would like to highlight, towards the bottom of the memo, is “Using Debt Prudently”. In this section Howard talks about the need to optimize debt, not maximize it. Even though Howard was talking specifically about investing, the notion of optimizing debt is very appropriate for financial planning.

We all have different circumstances and live different lives, therefore the appropriate level of debt will differ. Debt is also a very personal thing. Many people do not mind have an outstanding debt balance, others despise it. Sometimes it comes down to a choice and that’s okay.

With this all said, there are a few rules that I typically recommend. The following list is not exhaustive but it’s a starting point for a conversation. If you would like to discuss your financial plan, including your debt profile, feel free to get in touch with us anytime.

1)    Always use a comprehensive financial plan to model your debt payments. A financial plan can show you different scenarios to help decide upon a plan. For example, you can model the difference between using disposable income to prepay debt or invest.

2)    Utilize tax-deductible debt where possible. Some forms of debt are tax deductible, but others are not. This could be a key consideration when building out your financial plan.

3)    Consider whether there is any collateral/security pledged against the loan. For example, credit cards are unsecured compared to a vehicle loan that is secured against the vehicle. Hence the difference in interest rates between the two.

4)    Work with a financial advisor who can help break down the different interest rate options. For example, understanding how many interest rate hikes or cuts are priced into a fixed rate is very important information when making a decision on your mortgage renewal.

5)    Mortgages are the lowest cost form of personal debt. Consider and compare mortgage rates with potential investment returns before making prepayments.

6)    Try and avoid forms of debt with extremely high interest rates such as "buy now, pay later" plans.

7)    Spousal loans can be a valuable financial planning tool if the interest rate is attractive.

That’s it for this month folks. I would like to wish you a wonderful June and a Happy Father’s Day to all the amazing Dad’s out there! Until next time,

Chris

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