The Utility of Debt

There is a young man whose judgment and good sense I trust. However, when he got married “the old ball and chain” was not his lovely bride, but college loans.

We were chatting recently and he admitted that 80% of his budget that month was going into debt service. This is a remarkable amount to which we may credit both his frugality and also the value he creates for his employer.

However, this got me thinking. A lot of folks carry some load of debt. I do not recommend it. When I got my first credit card I promised my new bride that the month we paid a penny of interest on it, would be the month I cut it up. That was three decades ago. The last time I borrowed money for any purpose (a car and remodeling a house) was twenty years ago. I am very debt averse.

In fact, I paid off my mortgage so long ago I cannot remember budgeting for debt service. Thus I was in a quandary when I wondered how much I could comfortably save if I had to.

Dave Ramsey recommends that anyone in debt should pay it off as quickly as possible. I agree. He recommends a process he calls “the debt snowball” wherein the smallest loan is paid first, followed by the next-smallest, etc. Others recommend the process that I followed: “the debt avalanche” wherein the largest interest rate loan is paid first, followed by the next-largest rate, etc.

I believe the “snowball” is better suited to minimizing risk to the debtor whereas the “avalanche” is better suited to minimizing interest expenses.

I suspect the dollar difference between the two procedures ends up being not very large. And that gap narrows the more intensely you attack debt.

(If you have multiple loans at different rates, and would like to contribute to science, please share the details with me confidentially, and I’ll run simulations to compare snowball (vs) avalanche quantitatively.)

In either event, when you have debt and service that debt from your budget it tells you something important: After debts are paid, that money can go into savings with no change to life style.

This has application to anyone interested in FIRE (Financially Independent Retiring Early). A year or so ago my daughter turned me on to Mr. Money Mustache and the concept of FIRE. I’ve been a fan ever since.

The notion of FIRE is to develop sufficient passive income to live on that instead of working for the man. A rule of thumb is to save 25 times living expenses then work if you want or retire or live off side-hustles.

I like to call such money a “Forget You” (FU) stash. You may have heard another F-word used in this context.

Now, let’s combine this 25X with the 80% at the beginning of this post to derive something interesting.

One might expect the size of the FU stash to be 25 * income. But in this case, living-expenses are only 20% of that. FU needs only be 20% of what we would otherwise think.


In a year, someone with an 80% savings rate will be able to contribute Income * 80% to FU.


Now, if we ignore things like life-style inflation, interest earned, or pay raises, we can divide the first equation by the second equation to get the number of years to retire.


The beauty here is that income cancels out of both numerator and denominator so that we get


It doesn’t matter if you are making major bucks living on caviar or if you’re much more frugal and dine on catfood. Maintain that 80% savings rate and you’ll be FI in 6.25 years.

You may think that 80% savings rate is extreme. It is. But given the foregoing assumptions, we can plug in any value, r, for the savings rate into the formula above


For instance, suppose you have a 15% debt-service rate, (or you are now setting that much aside retirement) then r is 0.15 and we have 141.6 years. You’ll never have enough saved to retire!!

Oops. This is a crude model and it becomes less accurate as the rate drops to normal rates. It assumes you are earning 0% interest on your savings. When you have more than a few years, compounding becomes a big deal. And if savings are in a Roth account, compounding is even more significant.

Moreover, over the course of years, one can reasonably expect one’s skills to improve and one’s value to the marketplace to increase pushing the income up along with it. The rate may go up or down with time.

This analysis is most useful for the madmen who to set aside heroic percentages of income. If you can tolerate this hair-shirt existence for just a handful of years, you can set yourself up to live like nobody else after that.

The utility of debt is that by repaying it at a heroic pace, you learn frugality and have a solid figure showing you how much you can save.

Aside from that, debt is a stupid thing. Avoid it.

Steve Poling

Masters degrees in math and computer science. Poet in several computer languages. I write stories about Sherlock Holmes' brother Mycroft, steampunk, and SF.

Grand Rapids, Michigan