Debt in Moderation

Updated: Mar 28, 2019

“If you do not change direction, you may end up where you are heading.” Lao Tzu

Debt, like red meat is okay when consumed in moderation. Eating steak on occasion can be a nice indulgence, but when consumed three times a day for extended periods of time, issues like heart disease and high cholesterol are undeniably expected. The same can be said for debt. Excessive amounts of debt can cripple a family budget, delay retirement savings, and ruin the opportunity to obtain credit. Conversely, obtaining debt for positive future outcomes such as earning a college degree or owning a home is a requisite to improve one’s situation in our current society.

Managing debt appropriately comes down to proper resource management. A financial planning rule of thumb specifies that a family’s total debt, i.e. mortgages, student loans, and other consumer debt payments should be less than 36% of gross family income. The establishment of a budget can succinctly display income to outflow while determining how much debt could be utilized effectively as to not potentially burden the lender in case of financial emergency.

What happens when an entity like our Federal government needs to raise money? Two things can happen: the government can take on debt or they can increase taxes. In some cases, taking on debt is needed such as the case for issuing war bonds during World War II or borrowing from the Federal Reserve to stimulate the economy during the “Great Recession”. Certainly the sustainment of programs like Social Security are imperative as 48% of married couples and 69% of unmarried persons receive 50% or more of their income from Social Security.* Where does the government borrowing end? Below is a graph of government debt compared to GDP or Gross Domestic Product, a measure of all goods and services produced in our country.

Depicted by the graph, the U.S. debt has surpassed the nominal value of all goods and services produced within our borders. Over the longer term, and based on data by the Congressional Budget Office**, the debt ratio will continue to climb due to a rise in annual interest payments.

Based on the fact that borrowing without a plan to efficiently repay isn’t working, perhaps decreasing spending may spark a decline in national debt. While the premise seems logical, the chart below details that while spending has increased, revenues (i.e. taxes have not kept pace).

So where does this leave the American citizen? With the vast majority of spending needed to maintain social programs and the large population of baby-boomers retiring in large numbers, how will the government be able to fulfill obligations? What would a family do when facing financial hardship? Sure, they could try and lower expenses, however, finding another source of income may be necessary. In the case of our government, the alternative to curbing spending points directly to raising taxes.

We the citizens of our great Republic can do the best we can to create a plan to save and live debt free in retirement. To accomplish the task, one must persistently manage how money comes and goes, more importantly, how money will be shielded from the erosion of taxation. The time is coming for our elected officials to make sharp decisions and the opinion of many in the financial industry is that the imminent increase of taxation draws near to satisfy the revenue needed to sustain our national debt problem.

Nate Lovik, AIF®

Financial Planner, Strategic Tax & Retirement