One of the biggest causes of the financial crisis was debt: at personal, corporate and government levels. We all remember the 2008 stock crash and the corporate giants like AIG and Lehman Brothers that crashed and burned because of excess debt and leverage.
The crisis was alleviated only by transferring corporate debt to governments – nowhere more so than in the United States. Here, late in 2011, it appears the crisis was never really licked. The can was merely kicked off into the future.
As individuals, there’s little we can do to control the amount of debt governments and businesses take on, but we ARE in a position to minimize our own debt loads. You certainly want to retire all debt before you expect to retire, starting with high-interest credit card debt, then student loans, and finally lower-interest mortgage debt.
If you’ve gotten behind in your credit card bills, you know how quickly interest charges accumulate. A sure recipe for financial failure is to pay merely the minimum suggested monthly payment flagged on your credit card statement. If you can, pay off the full outstanding amount each and every month, and you can nip the problem of compounding interest charges in the bud.
Your attitude to interest is that you want to be a net recipient of interest, not a net payer of it. How do you receive interest? By owning GICs, bonds, fixed-income ETFs and other debt instruments, ideally in an RRSP or TFSA, since interest is harshly taxed at the top marginal tax rate if these instruments are held in taxable investment accounts.
While it’s true that interest rates are still low and likely to remain that way for a few years yet, it doesn’t mean that you should embrace debt by buying more house than you need. In inflationary times, some believe debtors “win” because they ultimately pay back their loans with “cheaper” dollars as inflation gradually erodes purchasing power.
The baby boom generation has known little but inflation, but the next decade could feature the opposite phenomenon of deflation – a thesis outlined by Gary Shilling in The Age of Deleveraging or Harry Dent Jr. in his recently published The Great Crash Ahead.
If deflation does arrive, it will hurt debtors and favour creditors, even if interest rates stay low. If you’re in debt and you lose your employment, it will be that much harder to service your debt. Decide now that debt is an albatross you don’t wish to live with, get out from under it and work to build up a nest egg where someone else is paying YOU interest.
Jonathan Chevreau is the National Post’s columnist and author of Findependence Day.
