More About Debt Management

I believe the article “Counseling Clients on Credit” ( JofA, Feb.00, page 61) failed to provide a balanced perspective. It praised and encouraged the use of “good debt,” calling it critical to any strategy for creating personal wealth, but said little of the inherent risk of assuming and extending debt over a long time period.

The article described the merits of minimizing a down payment on a home and even encouraged the use of a cash-out refinance to free up additional dollars for an investment in a long-term-growth mutual fund which could grow at a double-digit rate. However, given the volatility that exists in the markets today, double-digit growth rates may be unrealistic over short periods of time. In reality, most people do not stay in their homes more than several years, which shortens the time frame for comparing competing investments against your aftertax interest rate of debt.

Market history is full of periods when broad market indices stagnated or declined. The Dow Jones Industrial Average closed December 1972 at 1020. The next time it closed above 1020 was November 1982. Leveraged investments always carry more risk.

In some cases, early retirement of debt may be a great substitute for bonds in a diversified portfolio. Many middle-aged individuals should have at least a portion of their diversified portfolios in fixed-income securities. Failing to see the investment benefits of early retirement of debt and preferring to recommend your clients’ current fixed-income holdings could be a costly oversight with respect to their personal net worth. Once debt is eliminated, the debt payment can then be used to purchase a suitable fixed-income investment.

At what point do you tell a client it makes sense to retire debt? If it is always financially advantageous to be in growth mutual funds and pay interest on debt, should individuals carry large personal debt into retirement? CPAs must be able to competently counsel individuals about return and risk. If this sounds rather pessimistic and cautious, it may be what needs to be said to temper the recklessly optimistic perspective in the article. Debt always presumes on the future, and the miracle of compounding interest is a two-way street.

William B. Ertel, CPA
Charlotte, North Carolina