Tuesday, August 21, 2007

Debt Is Slavery

This is something they warned us about on Saturday during our law school orientation. Despite making near $150,000 starting salary at top firms, many lawyers want to leave the profession. The career services people encouraged us to keep our debt as low as possible to give us the flexibility to pursue a career that we love rather than one that will pay off massive law school loans. As one who spent several years working at a job I didn't enjoy very much, I think this is very good advice. Life is much too short to spend on something you don't like if other alternatives are available. One of the best ways to give yourself flexibility with career options is to keep your expenses low and to do your best to stay debt-free. (Following this strategy is what allowed me to leave my engineering career and come back to school as a full-time student.)

J.D. Roth of Get Rich Slowly (one of my favorite finance blogs) reviews a book by Michael Mahalik which offers this same advice:

The body of Debt is Slavery (and 9 Other Things I Wish My Dad Had Taught Me About Money) is just 88 pages packed with sensible advice about money. Like me, Mihalik made some dumb financial choices when he was young, and he spent years struggling to recover from his mistakes. Debt is Slavery is the distillation of all that he has learned about personal finance. If you've been reading Get Rich Slowly for a while, Mihalik's lessons won't be new, but he does an excellent job of presenting each point.

Here are the ten lessons the author wishes he had learned when he was younger:

  1. Debt is slavery. Mihalik discusses secured debt and unsecured debt, credit cards, mortgages, and more. He explains how working to pay off debt is little more than slavery: you're working because you have to.
  2. Money is time. Those who have read Your Money or Your Life will be familiar with this concept, the trade-off between work and dollars. Whenever you buy something, you're not just spending money on it — you're literally spending time. Money is a representation of hours worked, and when you buy frivolous things, you're squandering hours of your life.
  3. Possessions are a prison. This is a concept that I've only recently begun to understand. Kris and I have been on a de-cluttering kick lately. Slowly, and in stages, we've been purging much of what we own. This was painful at first, but has become more liberating with time. Mihalik has a few simple rules for controlling the stuff in your life — they're excellent.
  4. Don't let advertising brainwash you. I've written before about the insidious power of marketing. (And I have another entry on this subject coming soon.) Mihalik decries the Great Marketing Machine and its drive to hook us on status and fashion.
  5. Money buys freedom. Money cannot buy happiness, but it can buy freedom. Money can give you more options. This concept is closely tied to "possessions are a prison". (This section reminds me of The 4-Hour Workweek, which I will review soon.)
  6. Don't sell your soul for a salary. Money should not be your primary motive for choosing a career. Consider job fulfillment, educational opportunities, and personal values. Try to find work you love.
  7. Own. Mihalik admits this advice might seem to contradict his previous notion that possessions are a prison. "Income-consuming assets can imprison us, he writes (echoing the good part of Robert Kiyosaki's advice). "Income-producing assets set us free." Don't buy Stuff — instead, invest your money in things like mutual funds and real estate, things that make money and not consume it.
  8. Spend less than you earn. What can I say about this? It's the fundamental law of wealth. Mihalik explains how to meet this objective by controlling your expenses.
  9. Save 50% of your salary. This is the most ambitious advice in the book, but I like it. Mihalik writes, "Have you ever asked yourself how people who immigrate to the United States can come here, get a low-paying job, and open their own business five years later? How can they do that, making around minimum wage, when you can't, making more than minimum wage? They save. They save 50 percent or more of their salary. They don't go into debt, they work hard and make other sacrifices, so they can buy their own business and control their financial destinies."
  10. Control your money. In the book's final chapter, Mihalik lays down an approach to making all of these goals workable. He explains how to eliminate debt, minimize expenses, and create a financial plan.

Roth also links to these additional reviews of the Mihalik's book:

Mihalik's book looks like an excellent read and at 88 pages, very accessible as well.

Here are a few initial thoughts on the premise of the book. First analytically as an economist and second experientially as someone who has made his fair share of financial mistakes and successes. (Which is how we learn after all.)

Economic Analysis:

Economic theory treats debt as an intertemporal substitution of consumption. In plain English what this means is that you give up income in the future so that you can purchase something today. This may not always a bad idea, particularly in the case of students who expect to enter into a high paying profession. Incorporating the notion of diminishing marginal utility into the analysis, it may make a lot of sense to borrow when you're in school to "smooth" your income move evenly across your studying and working years. (The concept of diminishing marginal utility basically says that each additional dollar you make is less and less valuable to you – think about how much $10,000 changes the life of an average college student compared to its impact on millionaire. Borrowing while in school essentially takes less valuable dollars from your future self and transfers them as more valuable dollars to your present self.) The same logic applies towards saving for retirement. By saving money, you transfer less valuable dollars from your present self today to more valuable dollars to your lower-income future self.

I would add a couple of things to this analysis:

  1. Debt can be very bad, particularly if you overestimate your future income. The future is far more uncertain than most of us like to think. This is a particularly strong warning I'd give to students considering excessive loans. You may discover you have a passion for something that does not pay much financially but that has many tremendous non-pecuniary (non-financial) rewards.
  2. If you're not a student, most of this logic probably doesn't apply to you and may work against you. (People who get into trouble with debt often have inadvertently transferred more valuable dollars into less valuable dollars. In a real sense, that's probably how I'd classify most debt-relate financial issues.)

Experiential Observations:

While I do not think all debt is necessarily bad, I would advise anyone to be very cautious of it and only use it minimally. I once accumulated more debt than I should have and it took me longer to pay off than I originally expected. This played a role in delaying my start on my MBA which potentially also delayed the discovery of my love for economics. If I hadn't had debt, I may have started my journey into economics a bit sooner. Many of my friends have had similar or far worse experiences, with some having had to drop out of school, declare bankruptcy, and/or work at jobs they did not enjoy for years so that they could make debt payments. (Exactly what our law school's career services was trying to warn against.)

I've also seen the converse -- people who refuse to spend money to the point they never seem to get any enjoyment out of the money they make. I recommend a more balanced approach. In both cases (excessive debt and being a miser), people become a slave to their finances. Money makes a wonderful tool, but a horrible master.

My friends who seem to manage their debt the best are the ones who use it sparingly to enhance either their wealth or their income. They are the ones who borrowed to buy a modest home to live in, start a business, or switch into a career that had a high expected probability of earning more than enough to pay off their debt in a short period of time. They never relied on credit cards of home equity loans to finance these endeavors. (When I see people doing that, it's usually a sign of financial troubles ahead.)

Do I take my own advice?

I have been blessed enough to have made it through school so far staying debt-free. With law school starting and still having my dissertation to write before completing my PhD, I may have to take out a student loan before it is all over (possibly sooner rather than later). If the time comes when I do have to borrow money, I intend to do my best to keep it as minimal as possible. I want to have the flexibility to not be constrained with what type of job I get after graduation – whether that means deciding to teach at a small college or enter the legal profession in a public service-related capacity for a couple of years (and possibly a judicial clerkship) before entering academia. While in school, I am trying to strike a balance between not being overly miserly as a student and not living too far beyond my means.

Am I too debt-averse? Possibly. I hope to keep it that way. I'd encourage you to do the same.

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