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Personal finance wisdom cannot be universally applied to everyone. What might be “good debt” for you, might be “bad debt” for someone else.
Back in Grade 11, sitting in my first ever business class. There was a section about personal finance in the curriculum. We were taught things like the 4 Cs of credit, a little about banks, and maybe the basics of investing. It was a long time ago, and not enough financial literacy knowledge to be a fully functioning member of society. But at least it was there!
One of the things that stuck with me in that class was that we were told mortgages and student loans are good debt. Any credit card debt is bad debt.
I didn’t think much of it at the time. It was a rule to follow, and I had lots of time to worry about such adult concepts.
Then, I went onto university and then started working for a real estate company, managing their debt portfolio.
That rule I learned in grade 11, was presented as a universal truth. But since I had no context as to why mortgages are good, and credit cards bad, I would not be able to apply it to my own finances.
The world of personal finance is made up of so many rules that will never apply to everyone – which is why context to rules is important!
Just like knowing what makes up a number, like your net worth.
What struck me when I started working in the corporate world, was the stark difference in the approach to debt in personal finance, compared to how debt was treated in the business world.
In the business world, all debt can be good as long as you think about these two concepts:
- Return – is the return from putting the debt to use, greater than the interest rate?
- Opportunity cost – what are you missing out on by taking on this debt?
Of course, in the corporate world, it gets a little muddy when you add other nuances.
But these concepts apply just as much to personal finance, as they do to the business world.
So how do you apply these concepts to the world of personal finance?
Not all student loans are good
If you know a little about me, I’m a CPA based in Toronto, Canada. I might have even loved school so much, I took it on myself to take on additional exams, and actually got through two levels of the CFA (chartered financial analyst)
Before starting on the path to the CFA, I was actually exploring the MBA. The MBA though generally coveted is an EXPENSIVE masters program. Would it be really worth it?
That’s where I started connecting the dots in the business world to my own finances
As a CPA, I already had decent income potential.
Return: How much more are you making?
So really, I had to consider, how many years of additional earnings would it take for me to make back the money I would spend on the MBA.
If I was making an additional 10K more because of the MBA, it would take me about 10 years to recoup the cost of an MBA (somewhere in the realm of 100K).
But that’s not all.
Opportunity Cost: what would I miss out on?
An MBA would be a full-time program.
So with a 2-year program, I would also have to forgo, 2 years of full-time income, in addition to spending about 100K on the MBA.
Plus, any potential salary increases that I would already probably in the two years.
Is that now worth it?
Return and Opportunity Cost with Context
At the end of the day, for me the MBA was not worth it, based on just the math.
The additional return was not high enough in my situation. Plus there was a pretty big opportunity cost beyond just the cost of the MBA program.
Conventional personal finance wisdom, without context, would have said, student loans are good debt.
Therefore, it would be okay to take on additional debt.
But context is important in personal finance.
No personal finance rule applies to everyone at all times.
No universally good debt
In other words, mortgages and student loans are not universally good debt.
There are many situations where a mortgage might be considered “bad debt” because it would not add value to you based on your personal financial situation.
Maybe it would mean that you would not be able to afford to start your own business. Or that you would have no savings or emergency fund after you pay the down payment!
Or maybe you have no option between two jobs. One job is farther and would require you to take on an expensive auto loan, but also pays more. The other job might closer, would be accessible by transit, but with a much lower salary.
That is a more complicated situation, and there is no universal right answer for any person.
Every situation is different. Every person is different.
What are some conventional personal finance rules that have no applied to you?