Some debts are worth assuming, but others exert a drag on retirement saving.
Who will retire with substantial debt?
It seems many baby boomers will – too many. In a 2014 Employee Benefit Research Institute survey, 44% of boomers reported that they were concerned about the size of their household debt. While many are carrying mortgages, paying with plastic also exerts a drag on their finances. According to credit reporting agency Experian, boomers are the generation holding the most credit cards (an average of 2.66 per person) and the biggest average per-person credit card balance ($5,347).
Indebtedness plagues all generations – and that is why the distinction between good debt and bad debt should be recognized.
What distinguishes a good debt from a bad one?
A good debt is purposeful – the borrower assumes it in pursuit of an important life or financial objective, such as homeownership or a college degree. A good debt also gives a borrower long-term potential to make money exceeding the money borrowed. Good debts commonly have both of these characteristics.
In contrast, bad debts are taken on for comparatively trivial reasons, and are usually arranged through credit cards that may charge the borrower double-digit interest (not a small factor in the $5,347 average credit card balance cited above).
Some people break it down further. Thomas Anderson – an executive director of wealth management at Morgan Stanley and the author of the best-selling The Value of Debt in Retirement – identifies three kinds of indebtedness. Oppressive debt is debt at 10% or greater interest, a payday loan being a classic example. Working debt comes with much less interest and may be tax-deductible (think mortgage payments), so it may be worth carrying.
Taking a page from corporate finance, Anderson also introduces the concept of enriching debt –strategic debt assumed with the certainty than it can be erased at any time. In the enriching debt model, an individual “captures the spread” – he or she borrows from an investment portfolio to pay off student loans, or pays little or nothing down on a home and invests the lump sum saved into equity investments whose rate of return may exceed the mortgage interest. This is not exactly a mainstream approach, but Anderson has argued that it is a wise one, telling the Washington Post that “the second you pay down your house, it’s a one-way liquidity trap, especially for retirees.