Hard to farm dividends under water.

“Neither a borrower nor a lender be.”  Shakespeare wasn’t just a literary genius.  He was imparting financial savvy to the masses.

Unfortunately, many people missed The Bard as well as the financial intelligence available today.  They rack up debt like our government, which explains a lot.  It seems the debt load may be due to ignorance.

Ancient advice that's sound today.

As a Dividend Farmer, it’s important to understand debt because it’s hard to farm dividends under water financially.  Every dollar of debt incurred results in additional dollars stolen from your dividend operation because you have to pay back the dollar borrowed plus the interest accrued. 

The sad fact of our immediate gratification society is that people don’t think or know how much they’ll actually spend on debt when they make a credit card purchase.  Again, much like our government.

One way to address this is to learn about debt.  Practically speaking, it means understanding how much the debt will cost you during the period you pay it.  More importantly, how much of the cash pool won’t be available for seeding a Dividend Farm. 

With knowledge, it’s easier to make informed opportunity-cost decisions.  If the true cost of a purchase (original price + interest paid) is known, a reasonably comparison between that cost and the value of the item purchased can be made.  It’s also possible to compare the cost of debt to the investment money lost due to debt payments.

How does anyone, other than the lender, know how big the interest penalty will be so a comparison can be made?  A couple methods follow using an average credit card interest rate.

Wallet Hub’s Credit Landscape Report from January 2019 indicated the average interest rate on a secured credit card was 18.81% so we’ll start there.

Step 1:  Divide the interest rate (18.81% in this case) by the number of days in a year (365 for earthlings) to get the daily rate.  .1881 / 365 = .00051534.

Step 2:  Multiply the daily rate from above by the average daily balance from your credit card statement.  For example, Discover Card claims the average American household carried $16,061 in credit card debt in 2016.  Using that figure the equation would look like this:  .00051534 x $16,061 = $8.27.

Step 3:  Multiply the daily rate by the number of days in the billing period which is typically 30.  This equation would be:  $8.27 x 30 = $248.30. 

In this example, nearly $250 in interest is paid before touching the principle.  Shelling out $250 a month to cover 18.81% interest is a lot of money that could otherwise be put to use on a Dividend Farm.

Another way to estimate the price of interest is to use an amortization calculator like any of the free versions found on line.  An example Excel version is shown below.  Plugging the average balance from your credit card into the calculator along with the interest rate from the card and using a 5 year loan period (as requested by the National Foundation for Credit Counseling) results in an interest payment of $251.76 for the period.  This figure is close to the $248.30 payment calculated previously.

Free Amortization Table in Excel

In either case, you’ll sink over $3,000 a year in interest into a credit card company instead of putting that money to work on your Dividend Farm.  It doesn’t take many years at that rate to substantially, and negatively, effect a retirement portfolio.

It must be noted that credit card issuers may use different calculations.  For instance, they might calculate repayment on a 10 year basis rather than 5.  The interest paid during a 10 year payback would be $19,677 against the average debt of $16,061.  Conversely, a 5 year repayment would require paying “only” $8,836 in interest on the original $16,061 in debt.

Who wants to spend 50% to 100%+ the sticker price for anything?  Think about the Dividend Farming possibilities available when that much money ($25,000 or more in the above example) is available rather than paying it all to Discover, American Express, Visa, or MasterCard.

Dave Ramsey's Spot-on Advice

Understanding debt, managing it, or better still, avoiding it, can work wonders on your financial future.  If controlling small costs increases your dividend cash flow stream, think what eliminating big costs like excessive credit card debt can do?