Debt Won’t Just Disappear

in Debt Reduction

I have had a few folks take exception to my statements in Questions with an Answer: Get Out of Debt, in that they question whether it is more important to incur some debt to build wealth, than worry about growing debt, and if I could figure out how you type a Bronx cheer, I would, but I will simply say bunk!

The exact exchange was:

My response was simply, I would rather owe nothing. Savings of all kind can drop in value very quickly (depending on how it is being held), but debt will never magically decrease in value (and severity) without you doing something about it.

You may own a house worth $400,000 right now, and you have a mortgage that is for $125,000, however, it is not outside the realm of possibilities that the house could (in a very short period of time) be worth less than what you owe on it, then where are you? I have rarely (if ever) heard the opposite where suddenly your mortgage was forgiven and you owed nothing on your house, but your “Wealth” is mercurial.

The ephemeral nature of wealth is sometimes lost on folks, if I own $1,000,000 worth of BCM Enterprises Stocks (as options, which don’t vest for another 6 months) and I owe $160,000 on my mortgage,  my Net Worth is?

Anybody?

– $160,000

Correct! Stock options are worthless until  you see the money from the transaction in your bank account. I had over 10,000 shares of Nortel in options and 1 bright day they were finally worth $300, and then they were worth nothing again (as an obtuse example).

How about if I own a $1.5 Million home in a lovely section of the Beaches in Toronto, and I owe $400,000 on the mortgage, how much am I worth?

Anybody?

– $400,000

Correct Again! OK, that one is going to cause some comments, but, having things that you think are worth something is a wonderful thing, but until somebody pays for it, it is worthless. More likely than not my beautiful cottage in the Beaches (no I don’t live there) will sell for more than $1.5M if I tried to sell it, but maybe not.

One more: I have a Pension that is going to pay me 60% of my salary when I retire, I have $200,000 in my RRSP but I still owe $95,000 on my home, and I have $10,000 worth of other debt (bad gambling debts, let’s say), what is my Net Worth now?

Some might say: $95,000 at least because you have all that lovely RRSP money and that juicy pension, but do I?

If I cash my RRSP in, I am going to get SLAUGHTERED on taxes, and say this heavenly Bull Market we are in goes Bear very quickly, what am I worth? My Net worth would be closer to $0, and then you can figure out what you can valuate your pension however you like (but remember you have to live long enough to enjoy that as well).

All of this to say, that Wealth is Ephemeral, and can disappear like a Fart in the Wind, but DEBT is like an abscessing tooth, until you remove it, it will hurt and it will not go away until you do something about it!

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{ 15 comments }

{ 15 comments… add one }
  • Paul @paul_gagliardi June 6, 2014, 9:41 AM

    Great post and summed up perfectly! I know I would rather be debt free than have a high net worth.

    Reply
  • Bet Crooks May 28, 2014, 12:09 PM

    Not *all* of us, Brian. : )

    About the entire post, I’d say “S’truth!”

    I saw another example of twisted thinking on a financial chat board recently: someone said you don’t need any emergency fund so long as you have a HELOC.
    I found that truly troubling, especially when I wondered how many people are operating off the same belief.

    Reply
    • bigcajunman May 28, 2014, 12:57 PM

      You don’t need a parachute if you are jumping out of a crashing plane either, if you have a bungy cord ! Think about it 🙂

      Reply
  • Greg May 28, 2014, 9:50 AM

    I’ll buy your $1,000,000 unvested stock options from you for $1. I’d even pay $300. How much do you want for them? You can’t really count on banks not failing and CDIC collapsing so maybe your net worth is zero unless you’ve got gold hidden in a cave somewhere. I’m pretty conservative financially but I think you are taking things too far.

    I have no idea how you came up with the $400,000 net worth for the Beaches house example. Please explain.

    Reply
    • bigcajunman May 28, 2014, 10:07 AM

      Well that was a bit of a stretch, but what if suddenly there was plenty of affordable housing in Toronto, would my $1.5M home be worth that? The house is only worth $1.5M if I can find someone to buy it, maybe it is worth more, maybe less, but it is like Schrödinger’s cat in that you don’t know anything until you sell it. The house might have termites? Foundation issues, who knows? It was a more tenuous example.

      Reply
      • Phil May 28, 2014, 12:24 PM

        Recall what happened in the 2007/2008 financial crisis which pummelled the US? In the end, the value of an asset is only worth what other people are willing to pay for it 🙂 ~ My Own Advisor… 400K in housing, is not necessarily 400K in housing. It is more than likely somewhere between 200-350K after taxes, fees and other expenses. as to the comment re: options, yep there may be value, but it definitively not face value, but I agree zero is likely as well, so some reasonable assumptions need to be issued… In the end financial planning is just that a plan or estimated path, so go forth and make some reasonable assumptions. Bottom line is debt if you do not have a handle on it WILL cost you in the long run. – Cheers, and great article.
        – Cheers.

        Reply
  • Phil May 28, 2014, 8:39 AM

    Debt… leverage… life… wants… keeping up with what the neighbours have… Bottom line is people need to plan better and be comfortable living a life they can afford. Live on less than you have coming in. No magic. Debt is borrowing from the future to pay for the present, plain a simple. As you say, debt won’t just disappear and the masses need to understand it is just that simple. – Cheers

    Reply
    • bigcajunman May 28, 2014, 8:52 AM

      Living within your means? C’mon that’s just being a “worry wort” right? You can leverage an entire lifestyle by using credit! (all previous statements are sarcastic in nature and not to be followed).

      As usual sir, you have summed it up nicely.

      Reply
      • Phil May 28, 2014, 9:51 AM

        Thinking out load, as a credit score is something being touted to know, maybe more should focus on debt to equity ratio (liabilities/real or expected assets). I know for our household our ration is about 3.8%… very low. – Bottom line is if you ignore the importance of debt obligations on your financial well being, life will probably be a nightmare in the future as to dream you are living in the present – Cheers.

        Reply
  • My Own Advisor May 28, 2014, 7:47 AM

    Having some fun with the ol’ assets – liabilities stuff eh?

    Debt is an issue for us, I wrote about it recently as well, but the reality is, only holding small amounts of debt relative to large amounts of real assets and investments is a good thing.

    http://www.myownadvisor.ca/write-investing-200000-debt/

    If I was worth $2 M with house and investments and I owed $200,000, I could handle that. If I was only worth $500,000 with house and investments and most of that was my home, and I still had $200,000 in debt – that’s an issue.

    In the end, the value of an asset is only worth what other people are willing to pay for it 🙂

    Reply
    • bigcajunman May 28, 2014, 8:09 AM

      Wish I’d said that last part… 😉

      Reply
  • Brian So May 28, 2014, 4:09 AM

    Interesting take on debt. If we all used this method we’d all have a negative net worth. Now there’s a headline 🙂

    Reply

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