Repaying debt is building wealth

Repaying debt is building wealth www.wealthandrisk.nz

The following is an edited excerpt from my book WEALTH: Simple Tips for Young Professionals

Focus on your net worth

If there's only one figure that you should focus on when it comes to your finances, it should be your net worth. In simple terms, your “net worth” is your assets minus your liabilities*.

If you increase your assets, your net worth increases.

If you decrease your liabilities, your net worth increases too.

From a net worth perspective, putting a dollar towards paying off debt is the same as putting a dollar into a savings account.

Repaying debt is often a great investment

Many times, paying off debt can be the best investment you can make.

If you earn interest or dividends, you are taxed on that income. So a 6% return will look more like 4% after factoring in tax. If you have a loan where you’re paying an interest rate of 5%, you aren't paying tax on that "return", so the net return is actually better for you.

Usually, investments involve a degree of risk. The higher your potential return, the more likely you’ll lose money at some point. When you repay debt, there's basically no risk. You're essentially getting a risk-free return.

In most cases, you can think of repaying debt as making a risk-free, untaxed return on your investment.

Be careful!

I'd qualify this in a few ways.

  • If you pay some loans off, you may incur break costs, and these should be factored into any decision to repay debt.
  • Some debts also aren’t worth paying off quickly. If you’re living in New Zealand, your student loan is interest-free, and is also extinguished if you die. If anything, you’re incentivised not to pay it off early.
  • Some debt can be "good debt", particularly where it is tax deductible and/or used to buy an asset that will generate a positive return over time (for example, buying the right property, or paying money to buy into a profitable business). 
  • Despite the above, do not use this as permission to borrow money to buy things you can't afford! For example, don't use this as a way to rationalise borrowing money to buy a car. The net result of this decision is to put you in worse financial shape.

* Although you can include the stuff in your house (your contents) and your car(s) as assets, when I think about my asset and net worth position, I tend to write them of as being worth nothing. So technically, I look at an adjusted net worth figure that doesn't include lifestyle assets.

Sonnie Bailey

Sonnie is the founder and principal of Fairhaven Wealth.

Before founding Fairhaven Wealth, Sonnie worked in the legal and financial services industries for over a decade.

Sonnie first became involved with financial advice as a specialist financial services lawyer. For many years, he was an “adviser of advisers”, reviewing thousands of advice files prepared by hundreds of financial advisers, and providing feedback in relation to the quality and appropriateness of advice; industry best practice; risk management; and regulatory compliance. He has published work in industry publications and spoken at various financial advice conferences.

Sonnie has also worked with banks, investment management firms, insurers, and derivatives providers.

Sonnie has worked as a private client lawyer, focusing on succession, estate planning and trusts. He ran his own legal firm in Australia before relocating to New Zealand. He has also acted in independent trustee and company director positions.

Sonnie is passionate about helping people achieve their goals and manage the risks to which they are exposed.

He has written extensively on his blog, New Zealand Wealth and Risk, which can be found at www.wealthandrisk.nz.

Sonnie is married to his wonderful wife Chrissy, and has two young children, Ben and Anna.