With a growing number of young adults going into debt, what advice can parents give their children?
Debt is an obligation that cannot be taken for granted. Defaulting on a loan can result in lifelong challenges, in addition to financial and legal repercussions. The first step in considering debt is to understand that there is good and bad debt. Good debt leverages a ‘need’ that provides positive, long-term opportunities, such as buying a home or financing education. Bad debt can be thought of as all of the ‘wants’ in life or items you cannot afford or justify purchasing.
The earlier you start saving and the amount of money you save have a massive impact on what you accumulate over your lifetime. Debt drastically limits your ability to capitalize on the two most powerful concepts in finance: time value of money and compounding. The first refers to the concept that money you have available at the present time is worth more than the identical sum in the future because of its long-term, potential earning capacity. Compounding is a process in which an asset’s gains and dividends are reinvested to generate additional income over time. If you have debt, you’re required to service it by paying interest, which limits your ability to capitalize and build wealth.
The benefit of staying out of debt and living within your means is that every dollar works for you instead of going toward high interest charges. Having too much bad debt limits wealth accumulation, delays your ability to start investing and eliminates any compounding opportunity.
Brian Pultman
Founder & CEO
Correct Capital Wealth Management
Parents need to help their kids understand the different kinds of debt, along with appropriate and inappropriate uses of it since some are better than others. For example, borrowing money on a home can be a good use of debt, provided the down payment is suitable and the payments fit your personal budget. The house acts as collateral for the loan, and there may be tax benefits. On the other hand, using a credit card to take a vacation while unemployed is not a good use of debt.
Many young people today learn about the difficulty of too much debt the hard way, thanks to their relatively high student debt levels. According to data from the Federal Reserve, student debt now totals almost $1.5 trillion, or 10.7% of the total consumer debt outstanding. Fifteen years ago, student loan balances were about $250 million, just 3% of debt outstanding. Student debt isn’t necessarily a bad thing, since a college degree may increase your salary. However, more young people are struggling with their debt and wondering if they made the right choices.
Parents can help their kids figure out what kinds of debts are ‘good’ or ‘bad’ and determine the right level. Too much ‘good’ debt can be a bad thing. And while debt can be complicated, it’s also very basic: Don’t borrow what you can’t afford to pay back. For many people, parents included, that’s simple, but not easy.
David Ott
Chief investment officer
Acropolis Investment Management
