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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?

#51

Post by cperciva »

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…

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.

Correct idea, incorrect math. The optimum is found with (11+r)/(2 + 2r) consumption in year 1 and (11+r)/2 consumption in year 2, for a total utility of 2 log(11+r) - 2 log(2) - log(1+r); at (10%, 20%, 50%) interest rates this yields (3.33, 3.26, 3.09) total utility.

Re: Why Don't People Manage Debt Better?

#52

Post by usefulcat »

chkuendig wrote: post #37
usefulcat wrote: post #32

Earlier quoted context omitted.

I can see how a share buyback would put upward pressure on the share price, but how could it have a positive effect on earnings? Seems like it would have to have a negative effect on net earnings over the long term if the buyback was financed via a loan, due to the need to repay the loan.

Parent was writing about "earnings per share", key word being "per share". So with fewer outstanding shares, this obviously increases.

Ahh, ok that makes sense, thanks.

Re: Why Don't People Manage Debt Better?

#53

Post by pc86 »

Kurtz79 wrote: post #39
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…

"Only" 34% ? I imagine it is still a huge amount in absolute terms.

Yes, 34% of households is a lot of households. But part of the point of the article is that most people do not handle their debt well, however, most people with credit cards do not carry credit card debt month to month. It doesn't mean the article is wrong but it is certainly a point against the article's thesis.

Re: Why Don't People Manage Debt Better?

#55

Post by zrail »

Roodgorf wrote: post #33
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…

Wouldn't being able to continue your life unobstructed by the need for some potential purchases be an asset in the same way the parent described student or car loans as potential assets? If something comes up outside your usual cash flow, say a tire blows, and smoothing out that irregularity helps you keep your job, I would consider that a worthwhile investment.

Student and car loans are not assets. They are debts used to finance assets.

Re: Why Don't People Manage Debt Better?

#56

Post by jakub_g »

A big part of Daniel Kahneman's "Thinking. Fast and Slow" is devoted to economic behavior and in general, people are not rational when it comes to money - in some cases risk averse, in other risk seeking. He explains a lot of studies on the topic. If you have some spare time, I recommend the book (though it's not an easy read, as it's very information-dense).

Re: Why Don't People Manage Debt Better?

#57

Post by yummyfajitas »

cperciva wrote: post #51
yummyfajitas wrote: post #27

Earlier quoted context omitted.

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…

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. Correct idea, incorrect math. The optimum is found with (11+r)/(2 + 2r) consumption in year 1 and (11+r)/2 consumption in year 2, for a total utility of 2 log(11+r) - 2 log(2) - log(1+r) ; at (10%, 20%, 50%) interest rates this yields (3.33, 3.26, 3.09) t…

Good catch, I wildly oversimplified. That's what I get for doing arithmetic before coffee.

Key idea is that since utility is concave, smoothing it out is a win. Now just trade off the gains from smoothing against the losses from financing, and you are golden.

Re: Why Don't People Manage Debt Better?

#58

Post by bradleyjg »

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…

I don't think such an absolute position is warranted. It's true that saving up for a big purchase will end up costing you less money than borrowing to pay for it and paying it back. But you will have the item purchased for less time.

Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months. In scenario 1, you save $100 each month. The bank pays you 0.5% interest. As of January 1st next year you'll have a new TV and $2.75. In scenario 2, you put $1200 on a credit card with a 10% APR. You pay $100 each month towards the credit card bill. As of January 1st next year you have a TV you've been watching for a year already and owe $69. You've essentially paid $72 for the privilege of getting the TV you wanted a year earlier.

Is that worth it? Well that depends on a lot of things, some of them intangible, but I wouldn't say it can't possibly make any sense. The sort of Puritan attitude towards consumption and debt may not be the worst attitude to have, at least for oneself. But when combined with evangelism it is pretty annoying.

Re: Why Don't People Manage Debt Better?

#59

Post by gtk40 »

zrail wrote: post #48
gtk40 wrote: post #35

Earlier quoted context omitted.

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?

Several different cards. Sallie Mae Rewards MC from MC (sadly discontinued recently for new signups), Discover It, Chase Freedom, and Double Cash from Citi.

Re: Why Don't People Manage Debt Better?

#60

Post by maxxxxx »

anon4 wrote: post #24

Don't fall into debt. If you must fall into debt, then do so to a friend at no interest. If you still have to fall into debt, do so to a reputable bank and pay it off as quick as you can - sell whatever assets you have if you must. This of course applies to private individuals, not companies, banks or other institutions.

I would advise people not to lend money to friends and family. I have done it several times and every time it led to problems and a lot of pain.
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