Originally posted by @Christian Rojmar:
@George Gammon Great examples and certainly not feeling disrespected.
1) I respect that you are looking at it 100% from the financial side of things and I am not disagreeing with your math other than that you will have to pay capital gains tax at some point reducing that number depending on 1031 etc. However, I know many people that cannot function when debt is hanging over their head and while it may not be the best financial decision, paying of the debt sooner rather than later will give them piece of mind which is more valuable to them.
2) As for inflation and its effect on rental values, I am personally very concerned about the growing discrepancy between rents and income and something is going to have to give - i.e. is it reasonable for rent to continue growing with inflation or more while income is staying flat (in what seems to be best case scenario). I cannot see that scenario pan out... I would say the same for property values and how rapidly they are increasing compared to income. I would love to hear your thoughts on this because it worries me.
3) I have student loans that I pay absolute minimum on while investing in market which is providing compounded growth.
4) Reading back my poorly written comment,while it may sound like it, I am not saying that they should pay off debt ASAP unless it will give them piece of mind, and I am certainly not arguing that they should put any income into a savings account or an interest bearing note and let it sit. However, if debt is a concern, which it clearly is for this person, investing in the market with a return of 7-8% annually may be the better option due to the liquidity and not having to take on more debt (and you can leverage your position there as well if you want).
Christian, thanks for the well written and thought out response. You bring up a couple things I think are extremely important to address.
1. Some people can't function with debt over their heads. In other words, it makes some people feel good to not have any debt, because they feel like they're taking less risk, and if taking less risk makes someone feel good or sleep well at night than it's worth it.
If humans were rational this would hold merit because most would instinctively know probabilities/risk. Unfortunately, humans are the opposite. We are terrible at analyzing risk and probabilities.
As an example some people have a fear of flying but they'll drive 2 hrs a day in traffic, often without a seat belt. Or ask someone if they're more afraid of terrorists or catching a cold? Mass shootings or falling off a ladder? Hopefully these examples are rhetorical.
Bottom line people really really suck at accessing risk. And often, what makes us feel good, is actually far more risky.
Many on this thread have suggested the original poster do what ever is going to make her feel best. But isn't doing things that are uncomfortable because of cost/benefit part of what defines adult behavior? Going to the gym, working extra hours, studying in college, waking up at 6am, admitting mistakes, personal discipline, etc. If we never did anything uncomfortable because of a greater benefit in the future we'd all be 3 year olds.
And then take this to its logical conclusion. I'm sure everyone would admit there is a level of risk that exceeds the benefit of feeling good. Would you tell a friend to eat a cheesecake everyday or smoke because it makes them feel good? Of course not.
So what it then boils down to is measuring the actually risk of taking 200k and paying off student loans opposed to investing in positive cash flow rentals with 30 year fixed rate debt at sub 4%, because it makes them feel good.
In the prior post we established they'd lose around 800k...I think that qualifies as risk. Next, by paying off the student loans the poster will be 100% reliant on a job and traditional retirement plan, call it social security and 401k. (I'm assuming the poster never invests because of a continued irrational fear of debt). So they're totally at the mercy of an employer, the stock and bond market, and the US economy.
Remember how people are really bad at accessing risk. Get a good job, 401k, no debt...what most would consider low risk, is actually extremely high risk. Why?
The US is 23 trillion in debt (on balance sheet), we are the largest debtor nation in the history of the world, the US has a wildly inflated standard of living because of the USD status as world reserve currency, the stock market is at nose bleed levels, and the bond market has 15 trillion in NEGATIVE yielding debt. Additionally, the US is 11 years into an economic expansion, the longest in history. The next recession will come. When? We don't know, but based on history, sooner than later.
In 2009 the world economy nearly imploded because of debt bubble. Is debt lower or higher now? Much higher. The consumer debt bubble was merely transferred to a sovereign debt bubble. What makes 2019 10x more dangerous than 2009? In 2009 the private sector was bailed out by governments, in the next recession who bails out the governments?
I could go on and on, but the bottom line is there's a very good chance a good paying job might not always be there. There's a good chance a 401k won't be there. There's a 100% mathematical certainty social security will not be there. And there's also a good chance that rental property, in a linear market, in a good neighborhood, purchased with 30 year fixed rate debt, will be there...
So which is more risky? Paying off the student loans or buying the investment property? At the very least it's a toss up. ;)
I would argue it's much more risky to pay off the student loans, especially when you consider the loans maybe forgiven, therefore advising to pay them off because it would feel good, is similar to advising someone to smoke because it feels good.
2. And this is by far the most important topic you brought up. Can rents increase if wages are flat? I think you said you don't see this happening? Again, this illustrates how little most understand inflation. And I'm sorry to pick on you but it's imperative everyone gets this.
You're comparing 2 completely different things. Real (adjusted for inflation numbers) and Nominal (just numbers without an inflation adjustment.) 30 year fixed rate debt never changes, your first payment is the same as the last payment, it's a nominal number. When you compare your debt payment to your income stream (rent) you have to compare apples to apples. In other words, nominal numbers with nominal numbers.
What you're doing in your chart above is showing real (inflation adjusted numbers.)
I know this get's really confusing, really fast, so let's use an example using your chart above. According to your chart rents are 160% higher than they were in 1960 (in real terms.) Wages are 120% higher (in real terms.) A delta of 40%, which to your point, seem unsustainable at best, how could rents possibly go up? At some point people can't afford the sky high rents.
But remember those are inflation adjusted numbers and the debt is nominal. In other words real rents could come down while nominal rents could sky rocket. How? If the rate of inflation exceeds the rate of rents going up. In other words, if rents are going up by 2% per year and inflation is 3% per year, real rents are going down while nominal rents are going up.
Question: Will a dollar buy more or less in 20 years? If your answer is less, that's all that matters, rent's will be higher but the debt payments will be the same.
Let's go back to your chart one more time. Look at rents from 1970 to 1980. Didn't go up that much right? But when you run the numbers through and inflation calculator rent's more than doubled in nominal terms.
Your chart uses inflation adjusted numbers but the debt doesn't adjust with inflation. When you use nominal rents, with nominal debt, over 20 years, rent's will 100% of the time be higher.
The bottom line:
1. Paying off student loans is NOT less risky than investing, in the way I outlined, and IMHO it is irresponsible to advise someone to do it anyway because it feels good.
2. When analyzing any investment make sure to compare real (inflation adjusted) numbers with real numbers and nominal numbers with nominal numbers...debt is nominal, so it must be compared with nominal rents, which over time, will always go up.
Thanks again for your response, I hope I was able to shed some light on, at very least, how inflation works with debt. It's crucial to making good investment decisions over the long term.
George