Former investment banker and wealth manager Thomas Anderson has a message for financial advisors: Debt, not assets, will make the difference in your clients’ financial well-being.
“The biggest determining factor in whether or not you’re going to succeed long term is the decisions you make with respect to debt,” says Anderson, author of the new book “The Value of Debt in Building Wealth” and CEO of Supernova Companies, which hosts a lending solutions platform for advisors.
The book is geared toward college-educated people 25 to 55 years old who are earning more than $50,000 annually with a net worth less than 20 times their annual income. It includes recommendations that individuals, households and advisors can use.
Anderson argues that advisors and their clients should not view debt as a burden but as a way to buy more assets and save on taxes, which in the long run will lead to bigger retirement savings because of the power of compounding along with more liquidity and flexibility.
The key is choosing not to rush to pay off debt, specifically low-interest debt, which he calls “enriching debt.”
“If you’re paying 3% on a loan that enables you to leave investments that are earning 6% intact, you’re actually earning 3%,” writes Anderson.
There are, of course, other kinds of debt that aren’t so beneficial: oppressive debt, such as high-rate credit card debt, and working debt, such as mortgages and Small Business Administration loans, which make things possible like owning a home or a business that otherwise might not be, according to Anderson.
“Advisors need to think about debt,” says Anderson. “It has to be part of a financial plan…. If you’re just going to advise on assets and not advise on debt, it’s a mathematical fact that you’re not using all the tools and resources to give your clients the best advice.”
Anderson uses the examples of three types of households to prove his point: the “Nadas” who direct all of their savings to pay down debt; the “Steadys” who pay down their debt on schedule and also save; and the “Radicals” who pay down only interest on their debt, not principal, and save even more than the Steadys. At the end of 30 years, the Radicals end up with more savings because of the power of compounding.
“That’s why the decision with debt matters more than the decision with asset allocation,” says Anderson. “It’s driving the amount of money compounding over a long period of time. You can finance assets. Instead of tying up money in a house you can put it in your portfolio. Thirty-five years of compounding at a lower rate is more powerful than 10 years of compounding at a higher rate.”
Given this analysis, Anderson says financial advisors need to function as “personal CFOs” who manage both sides of a client’s balance sheets: assets and liabilities. Excluding debt management from a financial plan is “inexcusable,” says Anderson. “It’s a violation of the fiduciary standard. Financial advisors need have to have a debt philosophy. It doesn’t have to be my philosophy.”
Beyond defining the three types of debt, Anderson describes the different uses of debt over four phases of life: launch, independence, freedom and equilibrium, along with his tips on how to manage debt in each period: Launch phase. This the phase where young people, usually under 30 years old, find themselves. Anderson suggests they take on as little debt as possible during this stage, and preferably none. “Buy the least expensive car and drive the wheels off of it. Be as frugal as you can be. Don’t borrow early to buy a home.”
For those with college loans, he advises to pay off high-cost debt as quickly as possible and low-cost debt as slowly as possible in order to maintain funds if you want to change your job or you lose it. “Cash is the best form of insurance.” He recommends three to six months’ worth of cash reserves.
Independence phase. Anderson recommends that households consider whether to buy or rent a home and choose the former if they don’t intend to stay in one place for more than five years. “People underestimate the carrying cost for a house.” Buy and borrow what you can afford.
Freedom phase. This phase begins when a household’s net worth is two to five times their annual income – enough to own a home, save for retirement and service debt. Here Anderson recommends that there be no “oppressive debt.”
Equilibrium phase. In this phase households should be saving at least 10% of their income, though 15% would be better. “You don’t need to go above 25%. Once net worth exceeds 30 times earnings you don’t need to borrow,” Anderson says. It’s all about “how you balance enjoying life today and position yourself for the future.”
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