Global debt is staggering. Why that could be bad news for your retirement.

debt puts retirement at risk

The amount of debt in the world is staggering.

  • Auto loans recently passed $1 trillion for the first time and the average car loan is the highest it’s ever been, recently surpassing $30,000.
  • Student debt stands at about $1.4 trillion.
  • Mortgage debt is about $14 trillion.
  • More than 30% of households carry a balance on their credit cards. Those that do have an average balance of $16,000
  • The top 2,000 non-financial companies have $6.64 trillion in debt, $2.81 trillion of which they’ve added in the last five years.
  • The U.S. public debt has nearly doubled since the 2008 financial crisis, ballooning from $10 trillion to more than $19 trillion.
  • 20 years ago China had $500 billion in public and private and debt. Ten years ago that number stood at $3.5 trillion.  Today it is more than $35 trillion.

More than the amount of debt, however, is just how much of it has been added since the 2008 financial crisis.  After experiencing a debt induced financial Armageddon, you’d think individuals, companies and governments would be hesitant to go down that road again.  Not so.  Record low rates have fueled trillions (with a “T” like the Titanic) in new debt.  It’s like eating until you’re sick at a buffet and then deciding that the next logical step is to grab a new plate and see how many cheese enchiladas and Mini BBQ Brisket sandwiches you can fit on it.

And just like binging at the buffet is likely to end badly, binging on debt will usually end in a combination of regret and real world consequences.  How is all this debt affecting us and our ability to reach our retirement goals?

It’s causing stress.  A recent survey of adults with student loan debt showed that people would go to some pretty extreme lengths to get rid of that debt.  Nearly 57% would take a punch from Mike Tyson.  More than 40% would give up a year of life expectancy.  Almost 7% said they’d be willing to cut off their own pinky finger.  Think about that.  A not insignificant percentage of the borrowers polled would be willing to die sooner or hack off body parts if they could turn back time and get out from under their debt.  Living with excessive debt is stressful.

It’s making us financially fragile.  A recent Federal Reserve survey found that 47% of Americans could not cover an unexpected $400 expense without borrowing or selling something.  In other words, half the country is stretched so thin that they couldn’t afford a car repair or a new pair of glasses without some sort of payment plan.  There are likely many reasons for this state of affairs, but one is most assuredly debt.  In other words, we need to go into debt to fund new purchases because all of our income is already being used to pay for the debts from our old purchases.

It’s limiting our ability to save for retirement.  Each year the Employee Benefits Research Institute (EBRI) conducts a Retirement Confidence Survey to see how people are doing when it comes to saving for retirement.  In the most recent survey, nearly a third of respondents reported having less than $1,000 saved so far.  Two-thirds have less than $50,000 saved.  You don’t need to be a financial genius to know that $1,000 is not enough to fund a 20 or 30 year retirement.  Even $50,000 would only get you a year or two at best.  Why aren’t we saving more?  Again, one reason is debt.  If most of your current money is being used to pay for past purchases, you won’t have much left over for future savings.

It’s exposing retirees to market risk.  Even if you are near retirement and you have no debt, you may still be at risk from debt indirectly.  That’s because, with interest rates so low, many retirees have been forced to move further up the risk spectrum to get any sort of yield on their investments.  It used to be that you could put your money in a risk-free money market and earn 3%.  Now those same investments pay 0%.  Super safe bonds don’t yield much better, so many investors are shifting more of their portfolio to lower quality bonds or dividend paying stocks.  That works fine while markets are rising, but if we get another debt shock and borrowers can’t repay, then markets could tumble and many investors may find that they took on too much risk in their search for yield.

How much debt is ok?

To be sure, not all debt is bad.  Debt can be a useful tool when it’s used to purchase an asset or invest in a project that helps us to generate income and pay back the debt.  That said, in order to retire comfortably, the typical person needs to move from a place of low savings and high debt early in their career to a place of high savings and low debt later in their career.

What should that gradual reduction look like?  To help people track their progress, researcher Charles Farrell devised a Debt to Income Ratio and then established benchmarks for different age groups.  According to Farrell, your debt (e.g. mortgage, car loans, credit cards, etc.) divided by your income should be 1.25 at 40, .75 at 50, .20 at 60 and zero at retirement.

Retiring debt free used to be the rule rather than the exception.  Unfortunately, that is no longer the case.  In fact, a recent study by the Employee Benefits Research Institute showed that 65 percent of American families with a head of household age 65-74 had debt.  The age group with one of the biggest spikes in debt was 75 and older.

That’s troubling because debt adds risk and reduces cash flow, two things that can derail your retirement.  It is inherently limiting at a time when most hope for greater independence and opportunity.  It increases uncertainty at a time when most people want security.  So make a plan to gradually eliminate your debt and you will greatly increase your odds of having freedom, flexibility and peace of mind during retirement.

– Joe

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