The focus on debt in low level financial planning creates a fallacy. Debt, label it good or bad if you will, is really only important if it is costing you more to hold than you can gain from its use. Being debt free, but ignoring your obligations is purposeless.
With sophistication, we should consider a debt as a realized obligation transaction, much in the same manner that we have a paper loss and gain on an asset, when you actually engage a debt, it should take hold of an obligation, and put a price on it. The topic that I’m exploring today is that we know our debts, and therefore attach a lot of attention to them, but we often do not know our obligations.
The case of shelter need
I see this example as one of the most commonly misfocused debt/obligation situations. Many people promote renting vs buying, they come up with a myriad of reasons to justify this, but more often than not they are trying to fit logic to their decision to avoid the obligation of shelter need.
Successful millennial hipster slam-poet Bob is debt free, grows his own tomatoes and keeps bees on the roof of his Brooklyn rental. Bob is empowered because he paid off student loans, and is living the life of Riley.
Riley, on the other hand, went to medical school, graduated with 200K in debt, and bought an apartment with a mortgage. There’s $100K in equity in his home, and $600K negative net worth. Riley is riddled with debt.
The reality though, is that while there is a debt for Riley, when it comes to the future obligation to have shelter during later life, Riley will have paid down the student loans from the increased salary, and have a home that is paid off. The debt here manifests itself in the form of forced savings and also self improvement for salary increase. Even if both of these guys save the same amount into a retirement plan each year, Bob will have not addressed the obligation need of shelter when retired.
30 years from now, will Bob still be renting? What if both are debt free, but one owns a house and brings in $500,000 in salary, whereas the other makes $50,000 and still rents?
There’s nothing wrong with renting
The decision to rent vs buy should come down to an analysis of rental prices vs purchase prices and time to recapture any short term losses. If your time horizon is short, then renting is often wiser. There’s really nothing wrong with renting, and deciding which is right or wrong for you is important, it’s perhaps not as important as the broader picture. Are you renting and also setting aside enough money to meet your rent payments in retirement? That is an important obligation to consider.
Debt is external, obligations are internal
This makes it a lot easier to focus on debt. The lender will harass and penalize you for skipping debt payments, but who will harass you for missing your obligations? Your mother, your grandparents? Perhaps some silly blogger… Obligations are so hard to see, and this makes it easy to pretend that they aren’t present.
Obligations have variable durations and timelines
Not everything will be the black and white of working/retirement. One obligation that you may wish to review is college education for your kids. This basically starts the moment that you find out that you are expecting to be a parent, and becomes more important as time goes on. As a parent you have an obligation to decide on how to deal with this situation.
Obligations aren’t only about money
Earlier I mentioned that debt could be considered the realization of an obligation, IE you outsource it and quantify it. This is only one solution. When it comes to the college example above, you don’t necessarily need to price out college in 18 yrs from now, and pay exactly the correct amount of money each year into a 529 plan. That’s only one way to meet the obligation. Another way is to research additional routes towards funding, such as considering how to reduce college credit requirements through AP classes, or other ideas. Clearly, being able to pay for it all in cash is the most likely way to succeed in fulfilling the obligation, but it’s not the only one.
Be particularly worried if you are one of the F.I.R.E crowd
People who seek financial independence and early retirement are most at risk here, because if they miscalculate their obligations, they have done irreparable damage to their earnings capability. A silly example might be that you smartly price out your heating bill needs until age 90, and save enough, but you don’t realize that when you are no longer in your early retirement prime you might need more warmth… your older you might need some additional care and balance. Does your budget today factor in that you might need long term care when older?
What other obligations are there?
This is the hardest part. If you didn’t grow up in a house where financial education and responsibility were emphasized, you might not even know what obligations you might be missing, and as such never know that you’ve missed making payments on them. This could go on to shape and influence the reality of the world you see. A family that doesn’t address the college obligation might simply be of the view that their child can never attend college, and so many opportunities are missed.
Ultimately, everything can be offset with enough wealth, but spending money to meet obligations should only be done if it proves to be the most efficient solution, electing the cash route is electing to outsource the task. The biggest risk that there is might be complacency or refusal to accept your obligations, and getting to a place where you can make excuses that the goals are just too far from your grasp now.
Personally, I’m focused on college and on retirement savings. These are my ‘big two’ worries right now. I’ve been debt free for about 9 years, but I’m not obligation free by a long shot. I worry about money, because I have obligations, and I own them.