English philosopher William of Occam (1285-1349) lived in a time when the Black Plague swept through Europe —ultimately, in fact, the cause of his demise. He is credited with the principle of parsimony (colloquially known as the principle of simplicity), which states that when facing competing theories, one should always make the choice that requires the fewest leaps of logic. Complex, risky and/or sophisticated investments would, by definition, tend to violate that principle. Fortunately, there is a type of investment that can easily and immediately be tapped by the vast majority of Americans, one which can reap the potential of up to double-digit returns without a scintilla of risk: debt.
That’s right. Debt.
Debt Reduction and Interest Earned
With very few exceptions, every monthly debt payment carries an interest component. The amount of interest paid depends on the type of debt, its repayment structure, and, of course, the interest rate. A simple example is a home equity loan, a product millions of Americans utilize to access the equity in their residences. During its draw period (typically ten years), billing statements are interest-only. Thus, if $20,000 is owed and the interest rate is prime plus .5%, a 30-day billing cycle will be for $57.53. Most of us just write the check every month and move on to the next bill.
What isn’t as intuitive, however, is the savings a consumer enjoys by paying against something they already owe. For example, assume $500 drops out of the sky like manna from Heaven. Further assume our working couple referenced above doesn’t need it for bills and has enough financial discipline to not blow it at the local casino. They want to invest it, but aren’t sure what to do or how to do it. The money could go into a passbook savings account and earn around .20%, meaning in one year they’d have one additional dollar — not even enough for a Starbucks latte. On the other hand, were they to apply that $500 against the principal owed on a home equity loan, they’d pay $17.50 less over a full year to the bank. Put against the principal balance of a credit card with a 19.99% annual interest rate, the savings multiply further: almost $100 less interest paid to the credit card company over the next twelve months. No matter how sophisticated the investor, nobody can reliably earn 20% on their money more simply than that.
Earning money from the application of money. That’s the definition of investing, and by paying extra toward the principal balance of debt that’s presently owed, the consumer enjoys immediate financial rewards. It is the single most beneficial financial tool at their disposal.