Alcohol math. Wine multiplies itself by itself. The more you have, the more you are likely to have. And if it’s hard to stop at one glass, it will be impossible at three. Addition is multiplication. ~ Matt Haig, Reasons to Stay Alive
Debt math is exactly like that. The more you have, the more you are likely to have. And if it’s hard to stop early, it will be impossible later.
Economics has a term for this – debt spiral, which is a situation where an individual, or a business, or a country sees ever-increasing levels of debt. This increasing levels of debt and debt interest becomes unsustainable, eventually leading to debt default.
See this chart.
In 2004, at the Berkshire Hathaway AGM, a 14-year old shareholder asked Warren Buffett to share his top finance tips for young people.
Buffett replied –
If I had one piece of advice to give to young people, it would be just to don’t get in debt. It’s very tempting to spend more than you earn, it’s very understandable. But it’s not a good idea.
The big problem with debt is that it is easy to accumulate, but difficult to pay down. Whether you borrow as a business, or an individual.
Now, the reason debt is so much ingrained in our life is because it is older than money. In fact, as per David Graeber who wrote in his book titled Debt, money was probably invented not to help people struggling with barter, but instead to enable nation states to feed their armies, and for individuals to trade debts with one another.
So, how much ever you may want to get away from it, there is a risk of it lurking around the corner that you must watch out for. And also because one of the most lethal characteristics of debt, like drugs, is that it generally starts small, then slowly creeps into your life making you sort of an addict through the instant gratification it generates, and then takes you over.
The worst part is a lot of people take on debt not just to gratify themselves instantly, but also to gratify themselves more, and faster, than their neighbours and friends and colleagues.
Anyways, when it comes to debt and investing, here is a note from Tren Griffin of 25iq that explains it all –
Debt causes many problems, the worst of which is that the magic of compounding is working against you instead of for you. Leverage can also create situations where underperformance takes you completely out of the investing process. Since “staying invested” is a key to financial success anything that takes you out of the process is a very bad thing. As Charlie Munger has said: “I’ve seen more people fail because of liquor and leverage – leverage being borrowed money.” James Montier adds: “Leverage can’t ever turn a bad investment good, but it can turn a good investment bad. When you are leveraged you can run into volatility that impairs your ability to stay in an investment which can result in “a permanent loss of capital.”
In short, the math of debt is almost never in your favour, whether you take it in your personal life or for investing.
And like Matt Haig wrote for alcohol, even with debt, the more you have, the more you are likely to have. Addition is multiplication.
Paying interest on interest is a long-term trap. Avoid it, please!