In November, 2006, there was a discussion on The Motley Fool about when to borrow money. Another poster was surprised that his neighbor, a banker, had this rule: Never borrow money for a depreciating asset.
I thought it was great advice, and not at all surprised that it had come from a banker. Bankers see the terrible outcomes of badly managed debt. They also, from my experience, tend to be risk-averse. So even if there is a 10% return available, they’ll recommend a low-interest (but safe) CD at 3.5% instead. (I know because I had this discussion with my dad several times.)
Although it may not be the highest-return approach, it does have some merit. Many people do not have the knowledge to invest well. Many others don’t have the free cash to invest in no-guaranteed-return things without really hurting themselves.
My own preference is an incremental approach. (Yes, this sentence was in the original conversation. Yup, incrementalist before it was cool.)
If someone has all their money in a no-interest checking account, for example, I’m not going to start by teaching them a fancy stock analysis method and tell them to use it with LEAPS. (Whatever those are… even 13 years later, I still haven’t managed to understand them. Actually, I didn’t try very hard.)
Instead, I’m going to talk to that person about a 5.25% savings account over at Presidential Savings Bank. (Ha! Those have gone the way of the dinosaur!) Once they’ve got a solidly established emergency and freedom fund going, then I’ll talk to them about their 401(k) and IRA funding and going for 8% return on that money. (Via the matching and investing in boring index funds.)
When they’re comfortable at that point, then we can talk about 10% returns from stalwart, safe, boring stocks whose names they already know.
Step by step, that person will learn how to invest well. And we’ll probably have to talk about debt at the same time and in the same way. From the depths of credit card hell to playing the balance transfer game in order to invest the money, there are many variations on “smart” borrowing. Leveraging oneself is a wonderful thing to do and that’s why microcredit deserves a Nobel Peace Prize. However, there’s a learning curve there that has to be addressed and recognized one step at a time.
What I want to see bankers and other investment professionals do is recognize that learning curve, figure out where people are on it, and then take them another step toward their financial PhD — even if they only go from kindergarten to first grade.