Creating Wealth is an in-depth conversation between Bill Taber, an experienced financial advisor, and his millennial daughter about personal finance, investing, and financial planning.
Bill Taber is President of TABER Asset Management, a Registered Investment Advisor (RIA) and fiduciary firm located in Des Moines, Iowa since 1998. For decades, Bill has provided investment management services to clients, creating wealth, building wealth, growing income, and preserving capital for each and every client. TABER offers personalized asset management, wealth management, retirement planning, financial planning, and services such as 401(k) rollovers.
His daughter, Anastasia, lives and works near Washington D.C. She enjoys discussing finances and her cats’ latest antics with her dad.
Episode 17: Pay Off Debt vs. Start Investing - When should we focus on paying off debt and when can we start investing? Are there certain loans you need to pay down before you can really start putting money away towards investments? Bill and Anastasia discuss a common sentiment expressed by younger generations who are eager to build wealth and how to figure out what to prioritize. Bill mentions what the debt experts have to say on the topic. Anastasia relates what she learned helping friends through budgeting.
For questions and comments, you can email us at email@example.com.
Anastasia: Welcome to Creating Wealth, I’m Anastasia.
Bill: Hi, I’m Bill.
Disclaimer: The views expressed today are our own, solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investment strategy. The views are subject to change and are not intended as a forecast or guarantee of future results.
Anastasia: I feel like a lot of my generation, a lot of younger people are very eager to know how and when they can start investing, despite having maybe one, maybe multiple types of debt, types of loans. And we've talked about this briefly before in our investing episode, which everyone should go listen to if they haven't. But today we want to talk more specifically about when you can start investing versus when you should focus on paying off debt. Which debt should you prioritize? And we'll answer all of that in this episode. But I think a lot of people in my generation know that investing is such a powerful tool for wealth creation, that they feel like they're missing out on it and they want to know how we can get started on that? And they just really want to feel like they're making headway towards building wealth. They want to cash in on the great benefits of investing. So with that in mind, when should we focus on paying off debt and when can we start investing?
Bill: Well, I understand the urge to get started with investing, because right at this point in time, financial markets are doing quite well, real estate prices are going up, and stock prices are going up, and there's opportunities in the midst of this pandemic. Unfortunately, there's the priority that has to be acknowledged. And that is that if you have not built emergency funds, you really can't start investing yet. And if you have a lot of debt and some of its very high interest rate debt, then you really can't start investing yet. That's just the reality. An emergency fund is critically important to have as a way of keeping you from going further into debt if an unexpected expense comes up.
Anastasia: So say someone does have an emergency fund, but they have multiple kinds of debt-- they might have student loan debt from undergrad or grad school, they have a mortgage, maybe they have credit card debt, maybe they have a car loan or two--what would you say to that person?
Bill: Well, I would say that there are some debt gurus out there that would say you can't really start investing until you pay all that debt off. I don't think that that is necessarily the case.
Anastasia: That would be decades.
Bill: Yeah, and what that would do would be to cause somebody to miss out on that power of compounding that occurs when you start investing in your 20s and you keep investing over a period of 20, 30, 40, 50 years, and the compounding effect really makes you really wealthy.
Anastasia: Yeah, that's what we want!
Bill: Yeah, but the thing that's kind of in the way of that is that some of the debt that you have might be really high interest rate debt. Say you've got a credit card at 24%, or you've got student loans at 8%, the realistic returns from investing are probably somewhere in the 6%, 8% to 10% range, and so you need to pay off the higher interest rate debt that you have before you can start investing in these things that are going to create those kind of returns for you. Because if you have a 24% credit card, or if you've got a 8% student loan, paying that off is the equivalent of getting that kind of return on an investment, and so it just makes sense to pay it off. Until you get your loans down to the point where the interest rates on those are low enough that you can get a potential return that's higher than the cost of that loan. And that return would be somewhere around 6%, 8%, 10% percent.
Anastasia: Okay, I think that's really helpful to know, just because people might have more than one kind of debt. It'll be at different interest rates, and so say you even had two student loans, because I know that the rates on those vary quite a bit specifically with public versus private. So say you have a student loan, that's a 4% interest rate, and then you have another one that's a 10% interest rate, you're saying focus on paying off that 10% interest rate, and then you can start investing once you only have the 4% interest rate loan left?
Bill: Mhm. Because there's a higher probability that you're going to get a positive return from still having 4% debt on your financial balance sheet, but investing in something that returns 6%, 8%, or 10%.
Anastasia: Yeah, and I think something that's also really important to mention with investing. I mean, we've talked about this so many times, the type of investing strategy that you've always proposed or advocated is this long-term approach. And so you really want to make sure that this money--this extra money that you're putting away for investing--is that is serving you well in putting towards investing rather than paying off a higher interest debt. Even if you're super eager to get started with investing, it's really good to think about investing as, "When I start investing, it's going to be for the long term, and it's going to be with money that I don't need for any immediate expense"?
Bill: Mhm. Correct.
Anastasia: So what would you say to someone who is managing different forms of debt? Like they have a car loan, they have student loan debt, they're raising a young family--what advice would you offer to them?
Bill: Well, there are different approaches to debt repayment. Some of them are very specific and concrete, while others offer more flexibility. For example, there's an individual out there, Dave Ramsey, who has an approach called Financial Peace University. He's helped millions of Americans that were drowning in debt to get control over their money through developing a budget. And his approach to debt repayment is to pay off the highest interest rates first, and then once you've paid that highest interest rate, you then roll that payment into the next highest payment, or next highest interest rate. And keep doing that over and over and over until the debts are all gone. So that's one very specific, concrete, black and white way of doing it. Sometimes that highest interest rate debt that you have actually winds up being the largest amount, and people get discouraged, because it can take a longer period of time to pay off a larger debt.
Bill: And so there's an alternative to this, and that's paying off smaller loan amounts first, even though they might not be the highest interest rate to be able to gain the sense of a small victory, so to speak, a quicker victory so that psychologically you feel like you're moving forward faster, as a result of--
Anastasia: Making headway.
Bill: --making headway. You've got six or seven different loans, and some of them are pretty small. And so by paying off those small ones, even though they might not have as high an interest rate, just allows you to feel like you're making progress. And so that's an alternative way of doing it.
Anastasia: Okay, so you mentioned Dave Ramsey. What do the debt experts recommend that we do? Because there's more than just Dave, although he is a mammoth figure in the industry.
Bill: Well, Susie Orman has helped millions of people to understand what they truly can afford to spend, by understanding the difference between needs and wants, and to help build emergency funds to avoid falling into a financial hole that leads to bankruptcy. And so her approach would be, again, you know, pay off the highest interest rate loan first, and do it through understanding the budgeting process and understanding the difference between needs and wants. So it's a similar approach to Dave Ramsey. There's another individual that we've mentioned, Gail Vaz-Oxlade, that did a program that is now on YouTube, called "Till Debt Do Us Part," and she's helped young couples with no financial knowledge and no control over their money to learn to communicate with each other better, and to understand and control financially self defeating behaviors like excessive clothes, shopping, and entertainment expenses. And her approach is similar to, as you know, deal with the highest interest rate loan first. But make it a part of your budget so that we talked about 15% going into retirement savings, well make the next 15% debt repayment. Learn to live on the other 70%. But the key to that is to make sure that that 15% that you do for debt repayment becomes a budget item, just like food and shelter and clothing is.
Anastasia: Actually I saw someone on my Facebook who recently posted that he and his wife had followed the Dave Ramsey program, and were now completely debt free and paid off their student loans. So it is possible, but from what I've heard, it's very stringent.
Bill: Yeah, it works for some people. I mean, it's a very stark black and white type approach. I think it could work for some people that have trouble with savings and getting control, or say, over the use of their credit cards. And they might actually have to go cold turkey, and not do any investing at all, until all their debts are paid off. But there are other people out there that have some control over their budget, and they have the financial wherewithal or enough income coming in, that they can use some of that money to save for investments while paying debt down. And so that's where the concept of positive leverage comes in is that for those people, if they pay off the highest interest rate loans first, and then get down to the point to where some of those loans that they have left are lower interest rate loans, then they could conceivably invest some of that money instead of having to pay all the debt off, like Ramsey is suggesting. I'll give you an example of that. I had a house mortgage, and I think I probably had a car loan--this is earlier in my career--but in my job as an investment advisor, I was presented with an opportunity to buy stock in a company that had not gone public yet. It was a telephone company that was thinking of going public, and I was offered the opportunity to buy $10,000 of this stock at a price that I thought was at least half or less than what it would go public for within about 18 months. And so I went to a local bank, and I said, "I'd like to buy this stock." They looked at my financials and said, "Well, you're not over leveraged, so we'll allow you to use this money at an 8% interest rate cost to buy this stock." And as it turned out, the company did go public within 18 months at roughly twice the price that I bought it at.
Bill: So I got a 100% return and paid an 8% interest rate on it, to get into it. Those are opportunities people can get when they have a decent income, and they have control over their expenses. People that don't have that situation, and are prone basically to use credit cards and to supplement their income and spend on things that aren't necessary, that are wants not needs, maybe better go the cold turkey approach like Dave Ramsey and not do any kind of investing until they get the debt down.
Anastasia: It's based on how you as an individual are able to have control over your finances. Like if you have easy access to credit and you find yourself--maybe, this is actually interesting, because I've kind of informally helped a few friends budget. And they often find when they add up their expenses--they've never done it before, first of all, never looked at what they've spent in a three month period--and every time I do this, they always say, "Wow, I did not realize I was spending that much money on X." There's always at least one category where they're overspending, or they had no idea that they were really spending that much money.
Bill: And what's an example or two of those?
Anastasia: One of our friends was--
Bill: Delivery charges?
Anastasia: Well, it's funny if I give a specific example, then I will have friends ask me, "Are you talking about me?" (Laughs) Because that's happened before.
Bill: (Laughs) Okay.
Anastasia: And no, I'm not, because this is a very common thing. (Laughs) But one of the friends was spending too much on restaurants, and another friend was spending too much on Amazon shopping, would log on and "$10 here $20 here" really adds up. And it added up to at least $400 a month. $400 a month is something that can really put a dent in if you're saving for a house or if you've bought a house and you're paying off debt, or if you want to put away money for investing. I mean, that's real money. And it was kind of an unconscious, "I'll just spend here, spend there." And I think you know, it's not like any of these friends thought that they were being too crazy with their money because they obviously were not overspending in every category. So what probably was happening was that they felt like, "Hey, I didn't go out to eat in the last two weeks. So I think I'm justified and oh, I need this and that and this and that on Amazon." So they feel like they're cutting back on other parts of their life, but then that allows another category to kind of go out of control if they're not looking at it. It really opened their eyes when they had to sit down and categorize every single expense that they made in the last three months. And they realize once they see all the numbers added up. Oh, wow. Okay, that's where my money is going.
Bill: Yeah, and it caused them to become self aware.
Bill: And in the process of doing that allowed them to look at other priorities that are important to them that are longer term than that. And as you say, basically start over a period of time of shifting those from short-term rewards, or shopping or whatever into the long-term priorities.
Anastasia: Yeah, I mean, what's really interesting about the process of budgeting too was, and I didn't realize that we're going to talk about this in the investing episode (laughs), but I guess it's relevant.
Anastasia: When I was starting out, I asked you a lot of questions about my budgeting process, because I just had no idea. It's actually pretty straightforward once you sit down and do it, but I didn't know how to do it and I felt like at my first job, I was making more money than I ever thought I would--like I understood it wasn't all that much money, but it just felt like a lot of money to me because I had never had a full time job before.
Bill: Now that feeling I think lasts about six months into your adult career.
Anastasia: For some people, I think it lasts a little longer but (laughs)
Bill: (Laughs) And then insurance costs come up.
Anastasia: Right. So then I started actively budgeting and I was able to early on rein in any overspending that would happen for particular categories. It's gotten to the point now where I make those decisions when I purchase things now and I have kind of this subconscious sense of how much money I have and whether I could afford this thing. And what I should say no to so that I don't have to look at my budgeting every day. It's a sense that you can grow over time by looking at it specifically in the beginning when you're starting to get a control and handle on things.
Bill: Mhm. Yeah, that's what that process does for you and it helps you figure out how you can put money towards things that are really important to your long-term priorities that need to be kind of added to it over a period of time as opposed to your ability to just pay for it all at once.
Anastasia: Yeah. So we talked about the different debt experts. They all kind of say similar things, like, "Pay off the high interest rate debt," except maybe for Dave? I just wanted to clarify this. Does Dave say pay off all debt before you start investing?
Bill: Yes. So regardless of whether it's a credit card debt at 24%, or a student loan at 4.5%, he says, "Pay it all off, except for the house loan."
Anastasia: And what you said, to clarify, is that might work really well for some people who just need to be mentally unburdened by the specter of other loans?
Anastasia: That might work out really well for them. But I've also seen, actually, a random comment on Reddit mentioned that Dave Ramsey is a really good debt guy, but he's not a great investment guy.
Bill: Well, their entire program is helping people get that awareness that you spoke of, by developing a budget. And when they have the ability to control some of their money, then they talk almost exclusively about paying down that debt. And it isn't until that's done that they say, "Put money into Roth IRAs and retirement plans and start paying for your kids' college educations, and then accelerate the payments on your house so that you don't have that debt." And so it's all geared towards those priorities to get you to zero debt, so that you can then start to build wealth.
Anastasia: Which works for some people?
Bill: Which works for some people, but what I'm saying, in my career, I've talked to or deal with millennials, or advise millennials that are nearly 40 years old, that have been focused on paying the minimum amount on their debt payments over a period of now 10+ years, that suddenly look up and say, "I'm 40. I'm thinking I'd like to retire sometime in my early 60s. And I haven't done much in the way of building wealth for myself." That kind of gets to the fact that most of the entities that will loan you money for cars and houses, etc, are geared towards having you pay a payment to them each month for as long as possible, to give them as much interest earnings or interest expense as possible. And make sure that you're able to make the payment so that they don't lose money on lending the money to you. So it's geared towards their interest, not towards yours. Most financial institutions really want to keep you paying interest to them for as long as possible. (Laughs)
Anastasia: They're like, "Don't pay off that debt." (Laughs)
Bill: And the loans that they set up for you are geared towards, so in the early years, there's much more money going towards interest expense and not towards repayment of principal.
Anastasia: I know it's so rude. (Laughs) I mean, we see that on our mortgage statements, we see that they're allocating a lot towards interest. And it's, I don't like it. (Laughs)
Bill: (Laughs) Well, at least your loan is, what is it? 4% or less?
Anastasia: Oh, it's 3%.
Bill: 3%? Is better than the 9.25% that I first had to take out.
Anastasia: That just seems crazy.
Bill: I don't think we got into principal repayment until, what, year six?
Anastasia: Ah, jeez. They're just like, "Yeah, making money off the Tabers." I guess we didn't really answer this, but when they have repaid that debt, or they paid off the loans that are higher interest rate, and they have something that's more manageable--is less than what they could get from investments--I mean, we've talked about this before, but where do they then go to get started with investing?
Bill: Well, the combination of retirement plan investing, which because of the tax benefits that are involved in that. Common stock investing, which typically is returned 8%, 9%, 10%, as an average over the long haul. Real estate investing, that if you have a specific situation can return similar returns. But some people are aware of opportunities to buy into businesses or be financial partners in businesses with people that you know, that are really capable managers. So those are opportunities to do well.
Anastasia: Great. So it's kind of a choose your own adventure.
Bill: Yeah. And again, it gets to the fact that you need to understand what you're investing in, or you need to work with an advisor that understands it.
Anastasia: Yes, and we've talked about that before, so definitely check out our investing episode. We also had an episode about high income earners. I think that was a two part episode that is relevant to investing. And then of course, if you listeners are hearing us talk about this and you find you have questions, please, please email us. We'd love to answer any smaller questions within an episode, or we could base a whole podcast episode off of it like this one, if we feel like we have a lot to say about it.
Bill: Yeah, very appreciative for listeners to ask these types of questions, because this podcast basically has been a response to a question that an individual brought up that I think resonates with a lot of millennials.
Anastasia: Yeah, I can't believe that I talked about budgeting again. I was not planning to talk about budgeting again in this episode about investing.
Bill: Yeah, budgeting is really important to being able to come up with money to do investing. But we're going through a pandemic now and we went through in 2008, a downturn in the economy, and some people who basically decided they don't want to have to deal with things that potentially can lose them money. So they stay focused on stuff that's simply paying off a debt so that they only get into a hole again. That happened a lot during the Depression. They went into debt because they didn't have any money and so they focused on that for most of their career. It affected their mindset. It affected the way that they look at things. They never really got started in investing. In fact, they saw it as too risky. So if they did anything at all, it was putting money in a bank that had FDIC insurance and perhaps buying a CD from that bank as opposed to being open and investing in things that have growth potential, like stocks and real estate and businesses, etc. Budgeting is really the crux of any financial strategy because you have to have control of your finances to be able to allocate and prioritize what gets taken care of first.
Anastasia: So, great! Dad, do you have anything else?
Bill: Not today.
Anastasia: Awesome. Thanks, Dad.
Anastasia: Thank you for listening to Creating Wealth! If you liked our podcast, please subscribe and consider recommending it to your friends or leaving us a review on your podcast app. We would love to discuss your questions. You can email them to us at firstname.lastname@example.org. You can also find full transcripts of every episode on taberasset.com. That’s Taber with an “e” not an “o.” Thank you for joining us on the path to financial abundance. We’ll see you next time!