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D – E – B – T: Not always your typical 4 letter word

A lot of ink has been spilled over the concept of debt and how it relates to one’s personal finances.  Often times a specific answer is put forth from so called “experts” with a firm and decisive rule like “avoid debt like it’s the plague!!!”  Rarely is there a “one size fits all” answer to these types of situations so we thought we’d illustrate a different point of view.  Specifically, when asked by clients, friends, and colleagues if they should avoid debt the answer is, it depends.

While we think there are bad types of debt, carrying credit card balances is certainly one, there are other times when using debt to acquire something makes sense.  For a quick and dirty example let’s consider someone about to purchase a new home.  They have exactly enough  money saved up to purchase a $450,000 home in cash if they so desire, or they could go to the bank and get a mortgage for 80% of the home price and make a down payment of the remaining 20%.  Let’s say they were making this decision roughly 30 years ago (basically the duration of their mortgage).  Here are the facts that our example couple would be facing in December of 1988 as they weigh their decision.

Avg Mort Rate 12/1988: 10.34%[1]!
Home Price: $450,000
Down Payment: $90,000
Monthly Mort Payment: $3,250.08
Cash Reserve Need: $60,000


Now, for simplicity we’ll assume that the couple has two decisions.  The first would be to pay cash for the home, leaving nothing left to invest.  In this scenario they’re avoiding the massive 10% interest rate on the loan which seems great!  We’ll also assume that since they’ll own the home outright there isn’t a need for a cash reserve (they can get a home equity line of credit for emergencies) and finally they’ll invest what would’ve been their mortgage payment into the stock market.  Again, for simplicity we’ll assume they save it up over the course of a year and then invest the lump sum every December 31st.

Their second option would be to take a loan out for $360,000 at an interest rate of 10.34%/year over 30 years for the home purchase.  After setting aside $60,000 for an emergency fund (arguably conservative), the couple could invest their remaining assets ($300,000) in the stock market and let their portfolio grow.  In this example the couple won’t add to their portfolio since they’ll be making a mortgage payment each month.  If our couple really existed their potential mortgage would’ve been paid off at the end of 2018.  Let’s take a look at how they would’ve faired in each decision.



Scenario #1)

In this scenario the couple using all their cash to purchase the home outright and then will invest $39,000.96 (what would’ve been their mortgage payment) into the S&P 500 at the end of each year.  If we take the average new home sales price for each year they’re in the home we can get a pretty good idea of what they’re house would be worth today.  Based on US Census data[2] average new home prices rose 235.05% from 1989 – 2018 so they’re ending home value would’ve been approximately $1,507,736!  That’s some pretty good growth!  Also, important to point out is ultimately the ending home value would be the same in both scenarios so that asset will cancel out in the final calculation of comparing the couple’s final net worth.  Next they have their portfolio and its growth.  As you’ll remember this couple is investing what would’ve been their mortgage payment into the S&P 500.  So, at the end of year 1 (Dec – 1988) they invest a lump sum and repeat at the end of each year moving forward.  The end result of these investments would be a portfolio valued at $5,650,632.53 (that’s a nice-looking portfolio!).  Adding everything up their net worth would be $7,158,368.53, not too shabby, but could they have done better?  Let’s take a look at scenario #2.


Scenario #2)

Here the couple is going to borrow 80% of the home value and pay off the balance over 30 years.  This couple will stash $60,000 in cash away for emergencies and then invest the remainder ($300,000) into the S&P 500 and let it grow.  The couple won’t add to their investment portfolio since they’ll be making a $3,209.92 monthly mortgage payment.  As with the first scenario the home value will increase from $450,000 to $1,507,736 over the 30 years, which is exactly the same as in scenario #1.  Their $300,000 investment portfolio, however, would grow to $5,840,427 over the 30 years, outpacing the portfolio in scenario #1 by $189,794.50.  Wait, that’s not all either, in this scenario the couple stashed $60,000 in cash for emergencies, and if they haven’t touched that cash it would’ve also grown over the 30 years to $154,707 (invested in 3 month T-Bills)! The growth in the cash plus the investment portfolio outperformance ends up besting scenario #1 by $344,501.50!

We’ll almost never see a situation play out exactly like this in real life; however it does shed some light on the fact that some analysis should be done before making a financial decision like this.  Something that seems so “right” – not paying over 10% a year in interest if I have the cash on hand – can wind up being the sub-optimal choice from a net worth perspective.

Some things that might (most likely) change in real life with this example, all of which change the calculus:

  1. People rarely stay in their home for 30 years
  2. No one knows how the markets will perform in the future
  3. People will rarely leave their investments alone for 30 years
  4. We didn’t calculate the tax-advantage of mortgage debt in this example
  5. We didn’t monitor mortgage rates over the 30 years looking for opportune times to refinance the debt
  6. Generally, people don’t have a lump sum to purchase a home with cash
  7. In practice we find people have a hard time sticking to “invest the savings” strategies like scenario #1


A home is the largest purchase most people make in their lifetimes.  Thus, we wouldn’t expect every financial decision comparing borrowing vs paying cash to result in a $344k difference in net worth.  However all of the benefits (or costs) of these decisions compound over time and the cumulative difference of making all the right decisions vs using what seems to be common sense can wind up being massive.


We hope that at least this example lets you see that personal finance is just that, PERSONAL!  There are almost never universal laws that can be applied to everyone.







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