March 7, 2022

New Considerations for Managing Your Debt in 2022

Dwight Cass
Forbes, The New York Times & Wall Street Journal Commentator

The Ukraine war, rising inflation, and uncertainty over the direction of traditional investments like stocks and bonds are changing some of the considerations for individuals looking to manage their debt. Many of the traditional bits of wisdom remain valid: Target the high-interest, floating rate loans first, do not impoverish yourself by paying down too much debt too fast, and focus more on managing expenses than on betting that your income will increase, since that can be harder to achieve in uncertain economic times.

Today’s unique collection of economic factors does change the equation a bit. First, look at Ukraine. Few individuals have significant direct exposure to that country. But few had direct exposure to Lehman Brothers in 2008. But when Lehman’s failure almost brought down the money markets, a crisis that seemed far away took on uncomfortable real-world consequences for individual investors. 

In the case of Ukraine, the initial knock-on effect has been in higher energy prices, but there is also the worry that the severity of the sanctions against the Russian government will destabilize parts of the financial system, especially in the Eurozone. Some $6.7 billion had fled European assets in the week ending March 4.

Individuals should not make long-term personal finance decisions based on this type of news. But it does make sense to scale back any unnecessary exposure to newly volatile markets. One smart move is to eliminate any margin debt held through online brokers like Robinhood. This debt can be catastrophic in a downturn. It is used to buy stocks and will accelerate losses if the markets fall. U.S. investors have unwound some of their margin debt recently, but there is still a record amount outstanding.

Stock Market Margin Debt in US$ Billions

This is particularly risky for younger investors. Federal Reserve analysts wrote in November, “The median leverage [debt] ratios of younger retail investors are more than double those of all investors, leaving these investors potentially more vulnerable to large swings in stock prices, as they have a larger debt service burden. Moreover, this vulnerability is amplified, as investors are now increasingly using options, which can often boost leverage and amplify losses.” Investors looking to shield themselves from a downturn should prioritize paying back their margin debt, even if they must sell stock to do so.

Another debt management consideration is inflation. Usually, this helps borrowers by reducing the future value of their debt. Today, the government is so spooked by the surge in inflation – President Biden made it a centerpiece of his State of the Union speech – that it plans to raise interest rates to fight it. This has already caused mortgage rates to trend up, hitting an average of 3.76% on March 3, up from a low in the mid-2% range at the end of 2020.

That 3.76% is still extraordinarily low, and when you factor in 7.5% inflation, it still seems like a good deal. However, be cautious about taking equity out of your house at this point to pay down other debt. There’s no guarantee that housing prices will continue to spiral upwards. If they drop back to 2020 levels due to another economic downturn, you do not want to find yourself with a house that is worth less than your mortgage debt.

Ukraine, inflation, and today’s other unique circumstances might pass borrowers by without damaging their prospects. Nonetheless, they are an important reminder that it is good, and potentially crucial, to think through your debt exposures and repayment strategies considering changing circumstances.

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