Strategy Session – Managing the Debt Trap

Debt is a concept that most people are familiar and comfortable with from a relatively young age. By the time many Australians have reached 20, they have accumulated tens of thousands of dollars in student loans plus credit card debt and personal loans to pay for things like clothes, holidays and second-hand cars.

Unfortunately, the concept of saving and budgeting is less familiar (or perhaps just less appealing).

It is not until people hit their mid-to-late 20s that they start seriously thinking about saving, and it is usually for an overseas trip or a deposit to buy a property. They are effectively saving to get further into debt.

But debt is not necessarily bad.

Borrowing to invest in quality assets can be a highly effective long-term wealth building strategy, especially for high income earners.

Take global equities or residential property in Sydney or Melbourne for example. In the five years to 30 September 2019, international shares returned around 7% annualised1 while house prices in Sydney and Melbourne surged.

Gearing to invest in these asset classes back in 2014 could’ve turbo charged returns.

That said, gearing also has the potential to compound losses if the value of an investment falls.

Investing aside, too many Australians are simply borrowing to live. They are paying for all manner of things from groceries to insurance premiums with credit.

It is a dangerous habit that often ends badly because it is just too easy to overspend and let debt spiral out of control.

Since 2003-04, Australian household debt has increased 79%2. Australian households currently have the second highest debt load in the world, behind only Switzerland3.

A recent survey by the ABC found 37% of Australians are struggling to repay personal debt with almost half of millennials admitting they have a debt problem. 

This mean that any unexpected bump in the road, such as rising interest rates, unemployment or an unexpected illness or injury, will be disastrous for many families. 

We all know how precarious and uncertain life can be and it’s difficult to accurately predict the long-term direction of interest rates, which is why it is essential to track your spending and budget for known future expenses; understand the impact of debt on your lifestyle and financial position; and put financial buffers in place that allow for a spike in interest rates or a drop in income.

If possible, pay cash and only spend what you earn (*gasp*).

Utilising an offset account attached to a home loan to cover additional large expenses, such as private school fees or home renovations, ensures that you’re not paying ultra-high credit card interest rates.

The right amount of debt for you will depend on your personal circumstances including your age, goals, financial position and marginal tax rate.

There will be periods in your life when your debt burden is higher and saving is just too hard. Those in their 40s and mid-50s are probably nodding their head.

As the kids get older, you may need a bigger home. There may also be the cost of buying and running a second car, and general out of pocket expenses such as laptops, mobile phones and clothes.

Ideally, the goal is to be debt-free by retirement with a meaningful amount of superannuation.

To some this may sound like a pipedream but it possible with a robust savings and investment plan, effective debt and cashflow management, and a lot of discipline. The sooner you get started, the better.

Brett’s top tips for managing debt

  • Pay cash and don’t spend more than you earn
  • Budget for known future expenses
  • Track your spending. There are free and cheap Apps than can help you do this such as Pocketbook and Money Magic
  • Utilise an offset account attached to your home loan for larger, long-term expenses
  • Ignore offers to increase your credit card limit and any sort of personal loan, Afterpay and lay-by
  • Partner with a good financial planner who will help monitor your debt, income and spending, and keep you on track towards achieving your goals
  1. https://www.msci.com/documents/10199/149ed7bc-316e-4b4c-8ea4-43fcb5bd6523
  2. https://www.abs.gov.au/ausstats/abs@.nsf/Lookup/by%20Subject/6523.0~2015-16~Feature%20Article~Household%20Debt%20and%20Over-indebtedness%20(Feature%20Article)~101
  3. https://www.macrobusiness.com.au/2019/10/australias-vast-household-debt-a-giant-economic-millstone/