Upticks: Managing Debt

By Jake Falcon on June 9, 2021

Lots of people think debt is a horrible four-letter word that should be avoided at all costs. However, that is not always the case. On this week’s episode of Upticks, Jake explains how to manage and use debt as a form of leverage in your financial plan.

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Lots of people think debt is a horrible four-letter word. But it’s possible to manage debt and use it as a form of leverage in your financial plan. Many of our clients were raised by parents who grew up in the Great Depression, and were taught from a very young age not to owe anyone anything. It’s only natural that people who grew up in the 1930s, 40s and 50s, or even people with parents who grew up in that era, would think of debt as something to be avoided at all costs.

About a third our clients at Falcon Wealth Advisors are totally debt free; I of course think that’s great. But that doesn’t necessarily mean their financial plan is as healthy as it can be. You can have no debt, but if you withdrew a significant percentage of an IRA to become debt free, you may not have made the best decision, especially if you have to pay taxes and penalties on that withdrawal.

I don’t want any of our clients to think they have to be debt free in order to retire or be financially stable. However, to be able to leverage debt, it pays be a disciplined saver and investor.

Nearly every Falcon Wealth Advisors client has a financial plan, and each plan includes a target rate of return, often anywhere between 5 and 9 percent.  (Based on their unique goals, risk tolerance, asset base, etc.) Let’s say your target rate of return is 6 percent. That means on every dollar we invest for you; we’re seeking an average annual rate of return of 6 percent.

So, when we talk about debt with a client, if their mortgage rate is 3 percent, I tell them that may be a debt worth taking on. If a client borrows $300,000 for a mortgage but is then able to keep $300,000 invested in the stock market, they’re going to come out ahead if their target rate of return is more than 3 percent. If that target rate of return is 6 percent, for example, that client will net the difference between the mortgage rate and the target rate of return, which is 3 percent. Because they still have $300,000 invested in the stock market, they’re earning $9,000 a year they wouldn’t have if they used money from their portfolio to pay off their mortgage.

This may not sound like a lot of money to some people, but multiplied over 30 years, it’s significant. And the more money you have in your portfolio, the more money you have available to ideally compound and grow.

I understand how debt can be a psychological burden for some. But I recommend clients think of it this way: “I have the money to pay off this mortgage, but I’m just using it over here so I can have more in 20 or 30 years.” Of course, leveraging debt this way only works if you consistently make your mortgage payments, and are disciplined about how much you withdraw from your nest egg.

I recommend sitting down with your financial advisor to crunch the numbers and determine if it’s possible for you to leverage debt in your favor. We love meeting with clients to do this. And if you have high interest debt, like credit card debt, we can strategize with you to get that paid off.

The idea of leveraging debt is likely a new one for retirees and pre-retirees, as previous generations had pensions—many people today do not. But most Americans are charged with saving their own nest egg, and the corporate environment is much different than it was just a few decades ago. Our parents and grandparents didn’t leave jobs as often as we do, nor did they have to navigate Roth IRAs, health savings accounts and other investment vehicles.

In summary, I think it’s fine to have debt if your behavior matches up with the numbers. If you would like to meet with a team of financial advisors and planners who can prepare a financial plan to help you meet your goals, email me at Jake@falconwealthadvisors.com.

Clients choose to work with us to enhance their financial literacy and explain exactly what their financial plan means to them.

-Jake Falcon, CRPC®