How a little debt can help make you wealthy over time

September 08, 2019
Like popular radio show host Dave Ramsey, I want my clients to be smart about their debt. But unlike Dave, I don’t think being totally debt free is the best way for high earning doctors to accumulate wealth over time. The trick is knowing if your outstanding loans are “good debt” that you should pay off gradually, or “bad debt” that you should pay off as quickly as possible?

There are a lot of factors to take into consideration with debt, but here’s an easy way to measure if your debt is working for you or against you. And you only need two numbers: the interest rate on your debt (tax adjusted, if deductible) and the expected return on something you might invest those funds in. 

For example, let’s assume your mortgage rate is 4%. You’re able to deduct the interest, and are in an effective tax bracket of 32%. That would mean your actual interest rate after tax is 3.06%. (Interest Rate – Tax Rate x Interest Rate) You’re considering paying the balance down by $1,000 per month. What is the alternative on what you could do with that $1,000 per month, assuming you don’t need the funds for any short or medium term needs?

  • If you would otherwise spend it, paying down your mortgage can be a great (albeit illiquid) forced savings account.
  • If it would sit in cash earning 1%, debt pay down is also a reasonable option (3.06% > 1%).
  • If you would save it into a long-term investment portfolio for your retirement, the expected rate of return on your portfolio is probably higher than 3.06%. For example, over the last 10 years the S&P 500 has produced an average annual return of 11.65%, exceeding 3.06% by a lot. (important to note that past performance is not an indicator of future results)

Reviewing your liabilities is an ongoing process. I like to do this annually with my clients through their wealth action plan to make sure the rate, purpose and structure of their loans still makes sense. Debt, like money, is a tool and should be used wisely to build your wealth outside and within your practice.

The views expressed here are as of the date of publication and are subject to change. This information should not be construed as investment advice. It is presented for information purposes only and is not intended to be either a specific offer (or recommendation) Hayes Wealth Advisors to sell or provide, or a specific invitation for any investor. Information herein may have been obtained from sources believed to be reliable, Hayes Wealth Advisors is unable to warrant its accuracy.
All data, projections and opinions are as of the date of this report and subject to change.
Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results.
Hayes Wealth Advisors does not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be suitable for all investors.
Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Investments in foreign securities (including ADRs) involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration.