According to the Federal Reserve, household debt recently weighed in at a whopping 117.5% of disposable household income. That means that on average, we as Americans owe more than we make.
Unless you've got an incredible sweetheart of a deal, if you have debt, you're paying interest on it. That makes paying off debt a great return on your investment -- even better, it's a guaranteed return for your money. And guaranteed returns are outrageously hard to come by these days.
But the Market's on Fire!
The stock market may be doing incredibly well at the moment, but it wasn't that long ago that the Dow Jones Industrial Average (^DJI) -- now around 13,250 -- had plummeted to as low as 6,440. That sort of roller coaster might be a necessary part of generating investment wealth in the long run, but it is anything but guaranteed.
On the flip side, U.S. government bonds provide an ironclad assurance that you'll get face value back at maturity and interest along the way. The big problem is that even the 30-year Treasuries only carry a 3.4% yield, right around the long-run inflation rate. Take taxes out of that yield, and the only guarantee you're really getting is that your money will lose its purchasing power less quickly than if you stuffed it under your mattress.
There's an Extra $500 a Month in Your Future
Every dollar you're paying in interest on debt is a dollar you don't have available to save or spend on anything else. On top of that, even the principal pay-down part of your debt payment is cash leaving your pocket.
Once that debt is gone, both the principal and the interest payments go along with it, freeing up all that cash flow on top of the guaranteed return from the interest rate.
For example, assume you've got $12,000 in credit card debt, at 10% interest. (Yes, even so-called low-interest rate cards are averaging 10.7% these days.) If all you did was pay the interest, you'd be shelling out about $100 a month -- and you'd be stuck with that debt the rest of your life.
If, instead, you committed $500 a month to paying that debt, the first $100 goes to interest, and the other $400 goes to reducing the balance.
Once the debt is extinguished -- in just over two years -- you've not only made a guaranteed 10% return, but you've also freed up that entire $500 a month.
How to Get Started
Of course, the toughest part of earning those guaranteed returns is coming up with the extra cash to put toward the payments. Ultimately, that comes down to either earning more or spending less. In today's employment situation, earning more may be easier said than done, but if you can get paid for putting in a few more hours or find an extra part-time job, it'll be a ready source of cash.
On the flip side, we all have places where we could potentially cut back, such as:
- Carpooling or taking mass transit rather than driving alone
- Bringing lunch and/or coffee from home instead of buying it
- Adjusting the thermostat up a few degrees in summer and down a few in winter
- Cutting back on entertainment to just the things that really matter
Once you free up that cash -- either through working more or spending less -- you can go after that guaranteed return of paying off your debts. And when the sacrifices seem hard to handle, just remember how much "extra" money you'll have when you're free of debt. In that context, cutting back now seems like a small price to pay for future riches.