Should You Pay Debt When Inflation Is High?

Almost as hard to answer as 'should you smash your foot with a hammer?'

Inflation is over 7.5% officially.

Inflation is unofficially higher. I think the scientific term is “a metric fuckton higher”.

If you are like most people you have debt. You probably have a mortgage, maybe a car loan or two. If you are under 40 years old there is a good chance you have student loans still. And if you are an average American you are carrying around some credit card debt.

[Note - if you have 20% APR credit card debt outstanding, you need to get rid of that yesterday. If you don’t have the cash to pay it off right now, consider using the Inifinite 0% interest debt cheat code. At least then you buy some time and stop paying stupid high interest…and also make a few $100 in rewards along the way]

Now some of you may be thinking - “I do have too much debt…I am going to pay all my debt off right away, cut up all my credit cards, and make Dave Ramsey proud!!!”

Not so fast. Immediately paying down all your debt may not be the best way.

Dave Ramsey’s Snowball Method of Staying Slightly Less Poor

There are a lot of Dave Ramsey fans. Not sure why. He berates his audience to live life like paupers and pay down all debt immediately.

I imagine anyone who listens to Davey Boy and takes his advice is a masochistic sub who just likes being degrading and living a painful existence.

Who’s been a naughty boy? Did you buy a $3 coffee and put it on a credit card…? You aren’t living a miserable life to pay down your 2.5% yield mortgage faster? (ps - did you buy my book “baby steps” for $20, that is something you can splurge on")

**shudders**

I have a lot of issues with Davey Boy, but my biggest one is how unoptimal his advice is. He is costing his followers $1,000s in opportunity costs on multiple fronts.

Since this is an article on debt during inflation, I’ll stick to this single topic for now, so the 2 takeaways:

1. If the rate of inflation is a lot higher than your debt interest rate, you should consider only paying the minimum.

2. If there is an extremely low-risk investment with returns a lot higher than your debt interest rate, you should consider only paying the minimum.

Bonus - the snowball method is dumb af. Shove all your extra payments into the highest interest debt first. The snowball method is costing you $$$ every month. Davey Boy ‘the bald grifter’ Ramsey just knows the snowball method makes you feel like you are making more progress so you keep buying his rehashed trash advice books.

-BowTied F’er review of every one of Davey Boy ‘I con poor desperate people’ Ramsey’s books

High Inflation Helps Borrowers

Or said another way, if inflation is high, you should really reconsider paying down your low-interest debt fast.

Why?

You can think of inflation as decreasing the purchasing power of a dollar. If inflation is 10%, it means you can purchase 10% less ‘stuff’ next year for the same $1. So if you could buy a candy bar for $1 today and inflation is 10%, it costs $1.10 in a year. Therefore, you get less candy for your $1.

What does that have to do with your debts?

If inflation is ripping, the slower you pay down your debt the less “purchasing power” it costs you. How much less?

I’ll be honest. I intuitively understand how much inflation crushes your purchasing power, and I am a huge advocate of being strategic in how you manage your debt. But holy hell actually making this table reinforces the point.

How do you read the table?

$100 today will be able to purchase the equivalent of less than $80 in 5-years if inflation is 5% over that period.

Inflation is currently well over 10%, which means that $100 only gets you ~$60 of stuff in 5-years.

Look at the 30-year line at the bottom of the chart. Even at the ‘target’ inflation of 2%, your $100 will only be able to purchase about half of what it can today. At 10%, you have lost like 95% of your purchasing power.

95%

Bro, look at that and tell me why you would pay down your mortgage faster when to ‘save’ payments at the end. In 30 years, you esentially are paying nickels on the dollar in terms of purchasing power.

CPI Grossly Understates Inflation

“F’er, did you say inflation is well over 10% today? The CPI numbers have it only 7-8%".”

Good catch astute reader.

However, the CPI number reported by the government is extremely manipulated. You will have to wait for my post on CPI for all the details. But a quick overview here from the most recent CPI numbers, Feb 2022 (see CPI report here):

• Annual inflation was 7.9% with some of the big items being:

  • Food costs up 7.9% as well

  • Energy cost up 25.6%

  • Housing 4.7%

Right off the bat the 4.7% should jump out as not accurate. Numerous reports and anecdotal experience says rents & house prices are up 20%+. The 4.7% comes from surveys asking people what they think their house could be rented for. Most people who own their home have no idea what the rental market is like or what the going rate for their house is.

You can search and find numerous sources of data showing home costs are thru the roof.

Housing makes up a full 1/3 of the inflation number. So to have it listed sub 5% when the real numer is likely 4x higher already is hugely understating inflation.

Secondly, this is a year-over-year number, so more recent inflation is tempered down from being averaged in with lower inflation numbers 9-12 months ago (ie-there is a lag, particularly in something like gas costs which doubled in a few months).

Third, shrinkflation is not captured anywhere in the metric.

Shrinkflation is where the price of a unit of food stays the same, but the size of the unit decreases. If you have noticed the same $ amount on groceries doesn’t last your family the full week anymore, it is because the size of the containers is likely decreasing. If a box of cereal is $5, and previously it was 20 oz and now its 16 oz for $5, the CPI says no inflation since a box of cereal is still $5. However, it is the equivalent of ~25% inflation to you because you are getting 1/4 less food for your money.

Lastly, there is all sorts of hedonistic adjustments, seasonal adjustments (the numbers above are from the unadjusted CPI though), and re-weighting of the basket of goods that makes up CPI.

In short, the stated CPI is much lower than the real pinch on your wallet. Realistically, we are likely in the ballpark of 15% inflation.

So Inflation Is Higher Than Your Loans…

So if inflation is higher than your loans, what do you do?

If inflation is 8% and your loan interest is 3%, you could premptively buy items you need. For instance, food inflation is 7.9%. Buy 6 months of non-perishable food to eat and you are locking in a 8% annualized return. You need to eat anyway, so pre-buying food and storing it is essentially no risk return.

Or load up on toilet paper/paper towels/garbage bags/etc. Anything that you need for day to day life and won’t go bad will work fine here. (Note - this isn’t pre-buying things you just want. Keep it to food/toiletries/etc. Can’t flex you closet of toilet paper so no temptation to splurge).

8% return on your food > 3% interest on your loan = net benefit to you.

Now, if the government extended a pause on both the payments and interest of your student loans for 6-months, you could use the money that would be going to student loan payments to stock up on food. (ie 0% interest for 6 months, then back to your 3% interest…or more likely extended again since it is election season. Also, always the outside chance they get completely forgiven. You would feel like an a-hole if you rushed to pay your student loans and a month later find out it all would have been forgiven, right).

Putting student loan payments during the freeze into canned food & toilet paper is an easy arbitrage for anyone with 2 brain cells. You would have to be a complete dope to tell people to keep paying frozen student loans today with the current economic & political climate. I’d be embarrassed to recommend it.

This is so profoundly stupid. The government gave you a 6-month reprieve on payments and 0% interest. Even if you put your payments in a savings account at 0.01% for 6 months then took it out and paid it all told your loan you would be pennies better off. When your advice can’t outperform 0.01% interest you suck. (also linked to my twitter response to spare you from his feed)

Yup, you can outperform Davey Boy “the dope” Ramsey with your stacks of TP.

However, I get that this inflation example is a little esoteric. If you buy a bunch of food today, and then save 8% on your future grocercies, it is going to be pretty hard to track. Therefore, despite this being a great no-risk return, it may not hit home for you.

If only there was an extremely low-risk return that is higher than your loans…

‘Safe’ High-Return Investments Are Better Than Paying Down Debt

It is much easier to visualize your net benefit on an investment than on an inflation save.

If you can find a safe investment that has a much higher return than your loan, you should pay the minimal amount to your loan and instead invest in that safe investment.

If you could find a very low risk investment for 5% annual return when you have a loan for 3%, you would be better off putting any excess payments into the 5% investment instead of paying excess on the 3% loan. If you could find a low risk with a 20% yield, it would be a no brainer.

Lets do a quick example:

You have a 5-year loan for $10,000 at 3% interest. Let’s say every month you have $430 of cashflow after paying every other bill & expense. You could:

• Pay the minimum payment of $180 a month on the loan, or

• Pay the ‘Dave Ramsey stupid tax’ and pay $430 a month to pay it down in 2 years

If you were to pay $180 a month and invest the $250 difference into an investment with a 5% return monthly, you would have an account balance of $6,300 vs a remaining loan of <$6,200 at the end of 2 years. In 2 years, you could choose to pay off your entire loan and you made an extra $100 by investing. Not bad. (Basically, this is a 2% net return on your money)

What if you had a safe investment at 10%? You would be up over $400.

Maybe an extra couple hundred dollars over 2 years doesn’t seem huge. But no reason you need to pay off your loan at the end of the 2 years. You can keep stacking the $250 difference every month into investing.

At the end of 5 years that monthly $250 at a 5% return would be $17,000 account value and the loan will be paid off. Not bad. And don’t forget, 5 years from now that last $180 payment will buy the equivalent of $130 of products today.

Is there any sort of low-risk investment that can earn you that type of return?

Stablecoins To The Rescue

In the old world, safe investments were limited to savings accounts, CDs, and short-duration bonds. The yield on these suck right now.

However, we have a new option - stablecoins. If you aren’t familiar, stable coins are ‘pegged’ to the US Dollar. So 1 stablecoin = $1. They acheive the peg in numerous ways and explaining it is outside the scope of this post, however they have historically been pretty good.

What does a stablecoin yield? Anywhere from 3-20%+.

Now stablecoins are NOT risk-free. There is a chance of depegging from the dollar. There is some regulatory risk. And there is always the hacking/rugging/human error risks. As always, DYOR and look to diversify, and have a plan B.

If you are brand new to crypto and don’t want deal with the hassles of on/off-ramping, getting a wallet, finding a protocol, and farming your stables. There is even an option for you.

You can go to OKCoin right now and get almost a 20% yield on UST (Terra). Sign-up like any other brokerage account, link your bank account, and you can set up a re-occurring purchase for essentially no fees. So easy a boomer could do it.

Proof of Claim.

[Note - if you go the Centralized Exchange (CEX) route like OKCoin, just be aware of the common phrase ‘not your keys, not your coins’. You run the risk of the exchange cutting you off or limiting you / governement confiscation for the convenience. That said, I am staking UST on OKCoin in addition to my stakes on DeFi protocols]

Assuming UST keeps a 20% yield for the full 2-years in the earlier example, you made nearly $1,200 profit by investing the $250 difference monthly. And you made that in an investment that should be pegged to the dollar, meaning essential no loss to your principal. A ‘free’ $1,200 over the next 2 years starts to get a bit more exciting, no?

Summary: Should You Pay Off Debt Today?

Most likely No.

Unless you have absolutely no self control and would spend the difference on junk instead of investing it or buying non-perishable food.

I understand some people have an obsession of getting to $0 debt. You may have your identity wrapped up in being a Davey Boy ‘conman extraordinaire’ Ramsey disciple. Or maybe you grew up in a home where money was tight and you get anxious with debt. There is certainly a ‘peace of mind’ component of low debt.

I can’t put a $ on your personal emotional state and I genuinely don’t fault anyone for choosing to take a ‘guaranteed’ 3% return by paying down 3% debt. But if you are making extra payments solely becauase some ‘guru’ said to get out of debt as step 1 of some silly plan, I am here to tell you there is another way.

And you are likely leaving money on the table rushing to pay down debt.

You have 2 methods above to lock in 8% and 5-20% returns with little-to-no risk.

The only debt you have over 8% would be credit card debt. Get rid of that immediately at all cost. (I gave you the infinite debt cheat code above, but I re-linked here). If you have other debt over 8%, refinance it. And don’t be afraid to push the maturity out, you can always pay extra to pay it down faster. There is no reason to take the shortest loan length and force yourself to a higher payment. (who knows, inflation could be even higher in the future, so keep that flexibility).

I eat my own cooking here. In 2021, I refinanced

• A student loan from 4 yrs out to 10 yrs

• A car loan from 2.5 yrs out to 7 yrs

• A home loan from 27 yrs back out to 30 yrs

I dropped my monthly payments ~$750 and that money has gone to both buying a ton of non-perishables & dollar-cost-averaging into investments/stablecoins.

[Note - I have enough liquidity to pay off the balance of the student and car loan immediately if I had to. It helps to know you aren’t 1 missed paycheck away from the whole thing crumbling down.]

I sit cozy knowing that even if I make $0 return on my investments, 5-10 years from now the money I pay back to the bank will be worth 50-75% of the value they are now.