Should I pay off my mortgage or invest in the market?
I’ve been asked variations of that question many times over the years. I’ve read many of the experts and thought about how to apply that in practical principle to my own life. The easy answer is: It depends on what the market will do. The difficulty of predicting the future is the uncertainty of it all….
Of course the root of this question applies to all personal debt, especially ‘good debt’ like student loans – both how much is ‘safe’ to take out, and how quickly should it be paid back. The problem with debt is the inflexibility of paying it off. I have a short equation to help us understand this:
DEBT + TIME = RISK
We talk at length here about debt, and we’ve discussed risk, but most of us don’t understand how Time adds to our risk. Risk is the great part of personal debt that we don’t understand for two main reasons:
- Over time (1, 5, 10 years) when we don’t have any major pain from debt, we get comfortable with it so we stop feeling it as risk
- Our brain is specifically bad at predicting how we are going to feel in the future
To understand risk better, we need to understand the Volatility of Time
There is a time for everything,
and a season for every activity under the heavens
If we were to oversimplify the future, we would say it will contain good times and bad. Some times are even the best and worst at the same time, as Dickens famous novel opened. What we often fail to feel is what the author of Ecclesiastes was articulating – that life and seasons and times are full of good and bad. This is the way it is and will be but the current season won’t last forever.
Without wisdom, we humans are spectacularly bad at understanding the ebbs and flows of the times in our lives. When times are good, we double down on risks. I’ve helped a lot of people buy a house with twice the square footage after landing a higher paying job. Or when the housing market goes up, I’ve helped homeowners sell their recently appreciated house and roll the equity into a down payment for an even larger house. Of course, both of these came with much larger mortgages. It would be easy to put these people on blast if I didn’t do it myself. Working on 100% commission for over a decade, I’ve had my income either double or go in half four times. Wanting to live at peace inside that volatility has offered me a lot of time over the years to think about that means.
In addition to assuming good times will last forever, we often fail to understand the economic cycles that can undermine our ability to pay debt over time. Here are a couple of cyclical things that happen that are completely out of our control:
- Wholesale industrial change (Newspaper jobs, factory jobs, etc.)
- Our physical health
- Regular economic cycles (recessions, booms)
- Geographical shifts in availability of jobs (moving into cities, west, etc.)
- Cultural changes (see: declining denominational participation)
- Political stability (taken for granted in this country for several generations)
- Supply and demand of labor (a law degree isn’t that valuable if there are more attorneys then jobs)
- Individual companies closing (causing job loss)
All of these things are cyclical, but it’s highly likely that one of them will cause a change/gap in income in your future. It’s been widely reported that the average person will have seven careers in their working lifetime.
Now listen, you who say, “Today or tomorrow we will go to this or that city, spend a year there, carry on business and make money.” Why, you do not even know what will happen tomorrow. What is your life? You are a mist that appears for a little while and then vanishes.
Living with wisdom requires living in light of both good times and bad. The danger of debt is that it presumes upon the future. Its risk is higher if you carry large amounts of it over longer times.
Because time is a variable, you can greatly reduce the risk debt brings into your life a couple different ways:
- Exit Strategies
Good investors figure out how many ways they can ‘get out of a deal’. If you buy a building and the market changes you can rent it, renovate it into a different use, sell it for a loss (but get out of the deal), find different investors, hold it until the market changes again, or even give it back to the lender and declare bankruptcy. The more exit strategies you have UPFRONT, the more you can mitigate the risk. Many of these strategies involve getting out NOW, should the times change in a way where you don’t want to/can’t hold the debt for long periods of time.
This is one of the scary parts of student loan debt. Because you can’t declare bankruptcy and there isn’t a sale-able asset securing the debt, your ability to get out now is severely limited.
- Aggressive repayment
When you pay off a debt quickly, you acknowledge time in the equation. It’s why wealthy people say the number one key to building wealth is getting and staying out of debt. Without debt, your ability to navigate a future bad time is greatly improved.
Larry Burkett told a story years ago in one of his books (that I can’t find, but am remembering from memory) of a small business owner that used a line of credit at his local bank to help smooth out cash flow. He owed around $100k on the line of credit, but didn’t consider it much of a risk because he also had around $100k in cash at the bank. This arraignment worked quite well for some period of time. Unfortunately bad times hit during the savings and loan crisis of the late 80’s and his bank was shuttered. If I’m remembering the story correctly, as the books of the bank were settled his note was called due immediately by the auditors. Unfortunately, his $100k in cash was tied up in the assets of the bank and wouldn’t be available to him for months (if not years) until all the bank’s assets (his debt) were liquidated to pay the bank’s liabilities (his deposit). Even though he didn’t lose any money (FSLIC insured his deposit), what he thought was liquid (his cash deposit) became illiquid, and what he thought he could pay over time (his debt) became due immediately. Time caused a financial emergency.
I experienced a much smaller version of this same thing when my employer when out of business about 10 years ago. Our daughter had just been born but the medical expenses of her birth were not paid by my company/insurance because the assets of the business were frozen until all its accounts could be settled. My wife and I ended up paying about $4,500 to prevent the hospital from sending the accounts to collections. A year or two later, that money was released from the company and by God’s grace we were refunded all the money we had paid.
Time presents risks that are very difficult to prepare for. The point of calling it an ‘emergency fund’ is that we don’t know what the emergency will be, but we are prepared because we know there will be one over time.
Take a lesson from the ants
Learn from their ways and become wise!
Though they have no prince
or governor or ruler to make them work,
they labor hard all summer,
gathering food for the winter.
The lesson of this proverb – the seasons WILL change. Make a plan and execute it while you have the opportunity. When times are good, reduce your risks. When times are bad remember that no season lasts forever.
Does the amount of debt I’m considering only work out if everything goes well? How aggressive should I be in paying off debt once I graduate? Make a financial plan that accounts for all seasons, both good times and bad.
How am I reducing my financial risks over the next 1 year, 5 years, 10 years?