We often hear that advisors have more conversations about debt than almost any other topic (except perhaps taxes). These conversations tend to begin with a brief, “There is good debt and there is bad debt,” followed by a summation of why a particular debt meets one of the criteria with examples—for instance, a mortgage with tax benefits or even a low-interest debt with no tax benefits.
However, the financial impact is only one variable in the decision-making process as it relates to debt elimination. The other equally important factor for many of our clients is the emotional impact of carrying the debt. And frankly, not every financial adviser is equipped to have that conversation with a client, and not every client is willing to have that conversation with their financial adviser.
The conversations can be awkward for either party. Feelings are messy; embarrassment, regret, childhood experiences of money, perception of debt as always being bad, etc. are not easy to identify and address with logic so it’s not possible to have conversations about debt without factoring in emotions.
If you can have the conversation with your financial adviser, you’re in a good place to factor in both the financial and emotional. In my experience, once the debt is written down, your financial adviser can create a plan to both reduce or eliminate debt, and save or invest. It is often the unknown or lack of a plan that exacerbates the emotional.
What you ultimately decide will depend on your individual circumstances. However, before you press ahead with a plan, I would encourage you to consider the following in your process.
- Employer plan: If your employer provides a match for contributions to a 401k, 403b or other employer-sponsored plans, it may be wise to contribute at least the minimum amount required to obtain the full match.
- Emergency fund: Be sure you have or are contributing some amount toward a reserve fund, so you have cash available for an emergency. If you are eliminating debt and do not have a cash cushion, you may end up adding to your debt and, depending on the type of debt you are eliminating, it could be higher interest consumer debt.
- Interest rate: Not all debts are created equal. If your debt has a low interest rate, you may want to consider paying the minimum amount due and investing the difference, or at least a hybrid of debt elimination and investment.
Whether you decide to accelerate debt, pay the minimum and invest or some combination of the two approaches, I highly recommend you discuss your situation with a skilled financial adviser. It has been my experience that having someone else review your debts, your cash flow and your investment options through an employer or individually can make a significant difference in the comfort level with and commitment to the plan you choose.