Understanding the National Debt and your personal debt ceiling
If you spend more money than you make, you
are in debt. When the federal government spends
more money than it collects, it is in debt. It really
is that simple.
Debt Held by the Public = $16.17 trillion
Intragovernmental Holdings = $5.86 trillion
Total Public Debt Outstanding = $22.03 trillion
But let’s put it in historical perspective – the U.S. has
not been debt free since 1835, when President
Andrew Jackson decided to pay off the $75 million
debt of all the states by selling land in the western
part of the U.S. and blocking every spending bill he
could. So, on January 8, 1835, the U.S was debt free.
It lasted just one year.
Your personal debt ceiling
Reducing your debt burden is vital to you financial
well-being. But which comes first, paying off the debt
or saving and investing? In some cases, it is best not
to wait until you are out of debt to start putting your
money to work.
To decide whether to pay down debt or invest, look at
the interest rates you pay and consider whether you
could earn a higher after-tax rate of return on the
investments than the after-tax interest rate on the
For example, say you have a credit card with a
$10,000 balance on which you pay nondeductible
interest of 18%. In this case, it’s probably best to pay
off the debt because your chances of making an aftertax
rate of return greater than 18% are very slim.
On the other hand, let’s say you have a mortgage with
a $10,000 balance and you pay deductible interest of
6%. If your income tax rate is 28%, your after-tax cost
for the mortgage is only 4.32% ((6% x (1 - 28%). You
would generally need to earn an after-tax rate of
return greater than 4.32% to consider making an
investment rather than paying off the debt. If the
outlook for earning an after-tax rate of return greater
than 4.32% is good, it may be better to invest the
Of course, it isn't an all-or-nothing choice. You can
pay off debts with high interest rates first, and then
invest when it makes more sense than paying off
debt. Let’s say you have a $10,000 balance on your
card at 18% nondeductible interest and you owe $10,000 on your mortgage at a deductible interest
rate of 6%, and your tax rate is 28%. In this case, you
should pay off the credit card first.
When investing, keep in mind that the higher the rate
of return, the greater the risk, which can include the
loss of principal. If you make investments rather than
pay off debt and your investments incur losses, you
may still have debts to pay, but will you have the
money needed to pay them?
Debt, save or invest?
When deciding whether to pay down debt or to save
and invest, consider the following:
What are the terms of your debt? Are there
any penalties for prepayment?
Do you actually have money that you could
invest? Most debts have minimum payments
that must be paid each month. Failure to
make the minimum payment can result in
penalties, increased interest rates and default.
Are your funds needed to make those
How much debt do you have? How do you
feel about debt? Is it something you can easily
live with or does it make you uncomfortable?
If you say you save the money, will you really
invest it or will you spend it? If you pay off the
debt, you guarantee instant savings by
eliminating the need to come up with the
money needed to pay debt interest.
Do you have an emergency fund, or other
source of money, to use if you lose your job or
have a medical emergency, or would you
have to borrow? If you use your money to pay
off debt and needed funds later, would you be
able to borrow an additional amount? What
interest rate will you pay?
If your employer matches your contributions in
a 401(k), you should generally invest in the
plan to get the match. For example, if your
employer matches 50% of your contributions
up to 6% of your salary channeled into a
401(k) plan, getting the 50% match is like
getting an instant 50% return on your
contribution. There are also tax advantages to
investing in a 401(k) plan.
Reducing your debt burden is a critical component to
your well-being – that is indisputable. But eliminating
debt completely without saving and investing might
not be the best course of action for you and your
Your financial advisor can run different scenarios for
you in order to help determine how to proceed.
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