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Why Don't People Manage Debt Better?

blogs.scientificamerican.com

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Re: Why Don't People Manage Debt Better?

#41

Post by navait »

yummyfajitas wrote: post #27
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

Consumption smoothing is a perfectly valid use of debt. Suppose I have utility = log(consumption), but my income is volatile. If I have 1 income in year 1 but 10 income in year 2, and use no credit, my utility is log(1)+log(10) = 2.3. If I use credit, I can have utility log(5.5 / (1+r)), with r the interest rate. At 10% interest, that's 3.2. At 20% interest that's 3.0. At 50% interest that's 2.6. So even at 50% inter…

While that's a valid point, the parent was speaking in generalities across most people - given that most people have consistent incomes from wages, do they really need consumption smoothing?

Re: Why Don't People Manage Debt Better?

#42

Post by kdamken »

Better question: why do people buy things they can't afford and most often don't need, putting themselves in this position?

So many of my peers don't make a lot of money, but then still go out and buy a new or newish/used car and put themselves on a multiyear payment plan. "Oh but it's only 200 a month, I can swing that". Repeat for like 3-4 other things and suddenly they're always complaining they have no money and don't know why.

I highly recommend to anyone who's looking to take their financial situation more seriously do two things:

1. Read up on Mr. Money Mustache, a guy who managed to retire at 30. Even if you don't plan to retire early, it's eye opening to realize you don't have to spend your entire paycheck every month: http://www.mrmoneymustache.com/2013/02/22/getting-rich-from-...

2. Check out YNAB (You Need a Budget): https://www.youneedabudget.com/. Takes a little work to start using, but once you do, you'll understand your money in a way you never thought possible.

Re: Why Don't People Manage Debt Better?

#44

Post by venomsnake »

carsongross wrote: post #3

I used to think that the medieval western distrust of usury was backwards and foolish. Then I read about the roman experience with debt, and now I am far less sure of that.

Can you provide more info about romans and debt?

Edit: Somebody was faster. Thanks for posting links

Re: Why Don't People Manage Debt Better?

#45

Post by pc86 »

gspetr wrote: post #34

"The greatest shortcoming of the human race is our inability to understand the exponential function." --Albert Allen Bartlett Considering that 97% of the survey participants allocated their debt payments in financially suboptimal ways, perhaps the second greatest shortcoming of the human race is our inability to understand the compound interest. "Put God in your debt. Every stroke shall be repaid. The longer the paym…

Paying off debt in the way that saves you the most interest over multi-year timeframes may be optimal financially but is not necessarily optimal psychologically or logistically.

If you've got a 2% debt you can pay off in 6 months to open up $200/mo in cash flow that may be better psychologically than plugging away at $80k in student loans that are 4/5/6%. Yes 50 years from now you will have slightly less money. Suboptimal does not mean wrong.

Re: Why Don't People Manage Debt Better?

#46

Post by k__ »

I had a single mother and she had 3 bank accounts, all about 500-1000€ in the red for most of my childhood. This made me rather adverse to taking credits.

I only took one, for paying study fees. And it was "only" about 4000€ which I paid back one year after getting my first job.

After that I always tried to have enough savings to live from for a year.

Re: Why Don't People Manage Debt Better?

#47

Post by newjersey »

jonknee wrote: post #23
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

> Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and that is the only sensible strategy. Businesses use debt in all sorts of ways, they certainly don't limit it to buying assets. A common use recently is to fund share buybacks which is essentially an easy way to engineer higher earni…

I imagine when you "buy" your supplies and don't pay for them until about ninety days after you took delivery of the supplies, that is considered debt as well?

I mean if I want to ship something, Fed Ex will ask for payment up front but when Amazon.com ships something they probably don't actually send the money right away. I am still trying to grasp this concept credit terms. I must add that I have had no training in this field and have basically just skimmed through the soylent blog post

http://blog.soylent.com/post/133420708272/pricing-soylent-ef...

so in my mind, what we want to do is get the "interest-free loan" from our supplier of equal or greater duration to the credit term we give our customers.

I imagine this is a double whammy because suppliers offers better terms when the going is good and become strict when the going gets bad. Now that I think about it, perhaps Apple sitting on a pile of cash isn't such a bad idea after all right? I mean if they have to go through a rough patch again, won't any credit terms they get (banks, investors, or suppliers) automatically be worse? I don't know the rules about financial stuff but my perception is that as public companies there is only so much information you can withhold (and only for so long) without breaking financial regulations (and those regulations presumably exist for a good reason).

Re: Why Don't People Manage Debt Better?

#48

Post by zrail »

gtk40 wrote: post #35
zrail wrote: post #19

Earlier quoted context omitted.

> Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. In 2014 only 34% of households carried credit card debt month to month[1]. The majority of households pay it off every month, simply using it to smooth out irregular cash flow while potentially racking up rewards. They're not purchasing an asset, per se, unless you c…

I don't even think of myself as using debt. I see credit cards as a way to get an extra $50-70 a month in rewards[1] and increase my credit score. I have never paid a cent of interest. [1] I have a card that gives me 5% cashback in gas, groceries, and books up to a limit that does not often surpass what I spend and some rotating 5% cash back cards, in addition to a 2% general spend. I do not pay any annual fees for u…

Interesting. What card is this?

Re: Why Don't People Manage Debt Better?

#49

Post by Jtsummers »

DannoHung wrote: post #14
pilom wrote: post #8

This is showing that the Dave Ramsey "debt snowball" (pay off smallest debts first to get a psychological win and some breathing room by having fewer minimum payments) is a more effective way to get people to pay off many separate debts than paying off "highest interest rate first" even if it is less optimal for a rational actor. Just another case of people aren't 100% rational that many people have known for a while…

I have literally have people tell me that this is still rationality because it's the rational thing "for them". Like, the weirdest one was a cognitive psychology doctoral student. I mean, okay, if you can redefine rationality to be completely subjective, then sure, rationality is flargikriggendurf.

You're conflating rational and optimal. It is rational and optimal to pay off the highest rate debt first. It is rational and suboptimal to pay off the lowest debts first if you know you'll achieve success through this route. When presented with a $100k debt at 6% interest plus several $5k debts at 1-5% interest, the number of debts and the size of the large debt are overwhelming, psychologically, and people stop behaving rationally (and therefore also behave sub-optimally). The snowball method gets them to act more rationally (paying off their debts successfully), but still sub-optimally. It's closer to optimal, less debt, than the path of not paying.

EDIT: This is similar to any other sort of debt that people find themselves in. I weighed 220lbs, couldn't bench 100lbs (maybe 2 reps), and could barely run 1/4 mile at a 12-minute mile pace before wanting to pass out. So I was in a health/fitness-debt. Optimally, I could've set aside 2 hours a day to some combination of aerobic and strength training to achieve my goals in a short period of time. But that required a massive change of habits that was unlikely to stick. Instead, I ran 3 days a week (well, walk/ran at the start), learned to set aside my time for fitness activities, and improved my cardio. As I managed my time more effectively, I added in other fitness activities that got me to my strength goals as well. Adding it all at once would have (for me) been overwhelming and I likely would have failed (again) to make a routine of it. Adding in each part piece-by-piece was the far better strategy, and entirely rational, bypassing the normal anxieties of my mind by making the large change occur over several smaller changes.

Re: Why Don't People Manage Debt Better?

#50

Post by carlob »

yummyfajitas wrote: post #27
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

Consumption smoothing is a perfectly valid use of debt. Suppose I have utility = log(consumption), but my income is volatile. If I have 1 income in year 1 but 10 income in year 2, and use no credit, my utility is log(1)+log(10) = 2.3. If I use credit, I can have utility log(5.5 / (1+r)), with r the interest rate. At 10% interest, that's 3.2. At 20% interest that's 3.0. At 50% interest that's 2.6. So even at 50% inter…

Correct, but a bit misleading. You're taking a person that has income that increases tenfold over a year. For most people the rate of increase of income is smaller than credit card interest rates, and you can really justify high interest rates when you assume that you're going to make a lot of money next year, but then again Steinbeck said that most Americans think of themselves as temporarily embarrassed millionaires :)
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